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Traveling for Charitable Purposes

a horse named charitySometimes charitable work involves travel – such as for the Red Cross, for example. Did you know that your travel expenses for charitable work can be a tax deduction? Recently the IRS sent out a Summertime Tax Tip (2015-12) that outlines some valuable information about this deduction.

Tips on Travel While Giving Your Services to Charity

Do you plan to donate your services to charity this summer? Will you travel as part of the service? If so, some travel expenses may help lower your taxes when you file your tax return next year. Here are several tax tips that you should know if you travel while giving your services to charity:

  • Qualified Charities.  In order to deduct your costs, your volunteer work must be for a qualified charity. Most groups must apply to the IRS to become qualified. Churches and governments are qualified, and do not need to apply to the IRS. Ask the group about its IRS status before you donate. You can also use the Select Check tool on to check the group’s status.
  • Out-of-Pocket Expenses.  You may be able to deduct some costs you pay to give your services. This can include the cost of travel. The costs must be necessary while you are away from home giving your services for a qualified charity. All  costs must be:
    • Unreimbursed,
    • Directly connected with the services,
    • Expenses you had only because of the services you gave, and
    • Not personal, living or family expenses.
  • Genuine and Substantial Duty.  Your charity work has to be real and substantial throughout the trip. You can’t deduct expenses if you only have nominal duties or do not have any duties for significant parts of the trip.
  • Value of Time or Service.  You can’t deduct the value of your services that you give to charity. This includes income lost while you work as an unpaid volunteer for a qualified charity.
  • Deductible travel.  The types of expenses that you may be able to deduct include:
    • Air, rail and bus transportation,
    • Car expenses,
    • Lodging costs,
    • The cost of meals, and
    • Taxi or other transportation costs between the airport or station and your hotel.
  • Nondeductible Travel.  Some types of travel do not qualify for a tax deduction. For example, you can’t deduct your costs if a significant part of the trip involves recreation or a vacation.

For more on these rules, see Publication 526, Charitable Contributions. You can get it on at any time.

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Personality Influences Financial Decisions

The recent volatility in the stock market has everyone a bit uneasy – even folks who have worked with a trusted financial adviser for years. But if you’ve never worked with an adviser before, you may be surprised to find that one of the first things he or she will do is ask you to fill out a risk analysis questionnaire. This questionnaire is designed to help you understand your financial decisionsdecisions and the process of making decisions. It’s all tied to your personality, your own unique world-view.

Why is risk analysis important before you make decisions with your money? Risk tolerance is an important part of investing – that should be understood at the outset. But the real value of answering a lot of questions about your risk tolerance is to tell you what you don’t know – how the sources of your money, the way you made it, how outside forces have shaped your view of it and how you’re handling it now will help shape every decision you make about money now and in the future.

The most important thing a risk analysis questionnaire can tell is what’s important about money to you. Trained financial advisers can determine your money personality through a process of questioning discovery. Planners can then guide investors within their money personality. Do you want certainty? Are you willing to take a little risk or let it roll because long-term results are more important than short-term volatility? Or will you take more risks with your money because you can always make more of it?

A financial planner tries to see through the static to find out what you really need to create a solid financial life. But it might make sense to ask yourself a few questions before you and your planner sit down:

  1. What’s important about money to me?
  2. What do I do with my money? What do I plan to do with my savings?
  3. If money was absolutely not an issue, what would I do with my life?
  4. Has the way I’ve made my money – through work, marriage, windfall – affected the way I think about money in a particular way?
  5. How much debt do I have, what kinds of debt, and how do I feel about it?
  6. Am I more concerned about maintaining the value of my initial investment or making a profit from it?
  7. Am I willing to give up that stability for the chance at long-term growth?
  8. What am I most likely to enjoy spending money on?
  9. How would I feel if the value of my investment dropped minimally for several months? How about significantly over several months? What is a significant drop in value to me?
  10. How would I feel if the value of my investment dropped minimally or stayed constant (no growth) for several years?
  11. If I had to list three things I really wanted to do with my money, what would they be?
  12. What does retirement mean to me? Does it mean quitting work entirely and doing whatever I want to do or working in a new career full- or part-time? Or would I take on volunteer work in retirement?
  13. Do I want kids? Do I understand the financial commitment?
  14. If I have kids, do I expect them to pay their own way through college or will I pay all or part of it? What kind of shape am I in to help with paying for their college education?
  15. How’s my health and my health insurance coverage?
  16. What kind of physical and financial shape are my parents in? Are they enjoying retirement, and what does retirement look like for them?

One of the toughest aspects of getting a financial plan going is recognizing how your personal style, mindset, and life situation affect your investment decisions. A financial professional will understand this challenge and can help you think through your choices. Your resulting plan – from investments to insurance, savings to estate plans – should feel like a perfect fit for you.

Everything But The Retirement Plan!

drawing retirementConventional wisdom says that when you leave a job, whether you’ve been “downsized” or you’ve just decided to take the leap, you should always move your retirement plan to a self-directed IRA. (Note: when referring to retirement plans in this article, this could be a 401(k) plan, a 403(b), a 457, or any other qualified savings deferral-type plan).

But there are a few instances when it makes sense to leave the money in the former employer’s plan.  You have several options of what to do with the money in your former employer’s plan, such as leaving it, rolling it over into a new employer’s plan, rolling it over to an IRA, or just taking the cash.

The last option is usually the worst. If you’re under age 55 you’ll automatically lose 10% via penalty from the IRS (unless you meet one of the exceptions, including first home purchase, healthcare costs, and a few others), plus you’re taxed on the funds as if it were ordinary income. For the highest bracket, this can amount to losing nearly 50% or more of the account balance to taxes and penalties.

In addition, by cashing out you’re derailing the retirement fund that you’ve put so much effort into setting aside. If you cash it out, you’ve got to start over from scratch and you’ve got less time to build the account back up. A 2005 change in the tax law requires your old employer to automatically roll over your account into an IRA if it is between $1,000 and $5,000 (if you don’t choose another option), to keep folks from cashing out. If your account balance is more than $5,000, the old employer is required to maintain your account in the old plan until you choose what you’re going to do with it.

Another option has become available for your old account: you can roll these funds over into a new employer’s retirement plan, as long as the new plan allows it. In many cases this may make good sense, especially if the new plan has good investment choices and is cost-effective.

If the new plan doesn’t suit you or you’d like more control over your investment choices, you can always roll the funds from your old employer’s plan into an IRA. You’ll then be able to decide just how you want to allocate the investments, choosing from the entire universe of available investment options, rather than the limited list that many plans have available. Caution is necessary when doing this type of rollover, as a misstep could cause the IRS to treat your attempted rollover as a complete distribution, having the same tax effect as cashing out. Always choose a direct transfer to the IRA (rather than a 60-day rollover) and seek the help of a professional if you are unsure about how to deal with this situation.

But when would you leave the funds at the old employer? If the old employer’s plan is a well-managed, low-cost plan, and you’re happy with how your investments have done, then you might just want to leave it where it is. In addition, if you happen to be over age 55, you have the option available to access the funds immediately without penalty, rather than waiting until age 59 1/2 – but only if you leave the funds in the original employer’s plan. Plus, if your plan is a 457 plan (generally only available to governmental employees, such as with a state or local government), you may be able to tap the plan upon your ending employment without penalty as well.

Another good reason to leave the fund at the old employer is if you believe that there is a high probability that you may return to employment with this same employer. Especially in the case of working for a governmental unit, it probably makes sense to leave those funds in the old plan when you think there is a better than average possibility that you may return to work with the government (even another agency). This is because there are benefits available in some governmental plans that you would be giving up if you moved your account to an IRA, and you’re not likely to be able to move those funds back when you return.

So – hopefully this quick conversation has helped to clear up some questions, and perhaps it has brought up some new questions for you.

Social Security Trustees Report – 2015

truss-teesEvery year, the Trustees of the Social Security and Medicare trust funds release reports to Congress on the current financial condition and projected financial outlook of these programs. The 2015 reports, released on July 22, 2015, show that, despite some encouraging signs, both programs continue to face financial challenges that should be addressed as soon as possible, with the Disability Insurance Trust Fund needing the most urgent attention.

What are the Social Security trust funds?

The Social Security program consists of two parts. Retired workers, their families, and survivors of workers receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability Insurance (DI) program. The combined programs are referred to as OASDI. Each program has a financial account (a trust fund) that holds the Social Security payroll taxes that are collected to pay Social Security benefits. Other income (reimbursements from the General Fund of the Treasury and income tax revenue from benefit taxation) is also deposited in these accounts. Money that is not needed in the current year to pay benefits and administrative costs is invested (by law) in special Treasury bonds that are guaranteed by the U.S. government and earn interest. As a result, the Social Security trust funds have built up reserves that can be used to cover benefit obligations if payroll tax income is insufficient to pay full benefits.

(Note that the Trustees provide certain projections based on the combined OASI and DI (OASDI) trust funds. However, these projections are theoretical, because the trusts are separate, and one program’s taxes and reserves cannot be used to fund the other program.)

Trustees report highlights: Social Security

  • The combined trust fund reserves (OASDI) are still increasing and will continue to do so through 2019 (asset reserves increased by $25 billion in 2014, with year-end reserves totaling $2.8 trillion). Not until 2020, when annual program costs are projected to exceed total income, will the U.S. Treasury need to start withdrawing from reserves to help pay benefits. Absent congressional action, the combined trust fund reserves will be depleted in 2034, one year later than projected in last year’s report.
  • Once the combined trust fund reserves are depleted, payroll tax revenue alone should still be sufficient to pay about 79% of scheduled benefits in 2034, with the percentage falling gradually to 73% by 2089. This means that 20 years from now, if no changes are made, beneficiaries could receive a benefit that is about 21% less than expected.
  • The OASI Trust Fund, when considered separately, is projected to be depleted in 2035 (one year later than projected in last year’s report). At that time, payroll tax revenue alone would be sufficient to pay 77% of scheduled OASI benefits.
  • The DI Trust Fund is in worse shape and will be depleted in late 2016 (the same as projected last year). The Trustees noted that the DI Trust Fund “now faces an urgent threat of reserve depletion, requiring prompt corrective action by lawmakers if sudden reductions or interruptions in benefit payments are to be avoided.” Once the DI Trust Fund is depleted, payroll tax revenue alone would be sufficient to pay just 81% of scheduled benefits.
  • Based on the “intermediate” assumptions in this year’s Trustees report, the Social Security Administration is projecting that there will be no cost-of-living adjustment (COLA) for calendar year 2016.

What are the Medicare trust funds?

There are two Medicare trust funds. The Hospital Insurance (HI) Trust Fund pays for inpatient and hospital care (Medicare Part A costs). The Supplementary Medical Insurance (SMI) Trust Fund comprises two separate accounts, one covering Medicare Part B (which helps pay for physician and outpatient costs) and one covering Medicare Part D (which helps cover the prescription drug benefit).

Trustees report highlights: Medicare

  • Annual costs for the Medicare program have exceeded tax income annually since 2008, and will continue to do so this year and next, before turning positive for four years (2017-2020) and then turning negative again in 2021.
  • The HI Trust Fund is projected to be depleted in 2030 (unchanged from last year, but with an improved long-term outlook from last year’s report). Once the HI Trust Fund is depleted, tax and premium income would still cover 86% of program costs under current law. The Centers for Medicare & Medicaid Services (CMS) has noted that, under this year’s projection, the HI Trust Fund will remain solvent 13 years longer than the Trustees predicted in 2009, before passage of the Affordable Care Act.
  • Due to increasing costs, a Part B premium increase is likely in 2016. However, about 70% of Medicare beneficiaries will escape the increase because of a so-called “hold harmless” provision in the law that prohibits a premium increase for certain beneficiaries if there is no corresponding cost-of-living increase in Social Security benefits. If there is no COLA for 2016, the increased costs may be passed along only to the remaining 30% not eligible for this hold-harmless provision–generally, new enrollees, wealthier beneficiaries, and those who choose not to have their premiums deducted from their Social Security benefit. If so, these individuals could see the base premium rise to $159.30 in 2016, up sharply from $104.90 in 2015.

Why are Social Security and Medicare facing financial challenges?

Social Security and Medicare accounted for 42% of federal program expenditures in fiscal year 2014. These programs are funded primarily through the collection of payroll taxes. Partly because of demographics and partly because of economic factors, fewer workers are paying into Social Security and Medicare than in the past, resulting in decreasing income from the payroll tax. The strain on the trust funds is also worsening as large numbers of baby boomers reach retirement age, Americans live longer, and health-care costs rise.

What is being done to address these challenges?

Both reports urge Congress to address the financial challenges facing these programs in the near future, so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public. As the Social Security Board of Trustees report states, “Social Security’s and Medicare’s projected long-range costs are not sustainable with currently scheduled financing and will require legislative action to avoid disruptive consequences for beneficiaries and taxpayers.”

Some long-term Social Security reform proposals on the table are:

  • Raising the current Social Security payroll tax rate (according to this year’s report, an immediate and permanent payroll tax increase of 2.62 percentage points would be necessary to address the revenue shortfall)
  • Raising the ceiling on wages currently subject to Social Security payroll taxes ($118,500 in 2015)
  • Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later)
  • Reducing future benefits, especially for wealthier beneficiaries
  • Changing the benefit formula that is used to calculate benefits
  • Changing how the annual cost-of-living adjustment for benefits is calculated

Regardless of the long-term solutions, Congress needs to act quickly to address the DI program’s imminent reserve depletion. According to this year’s report, in the short term, lawmakers may reallocate the payroll tax rate between OASI and DI (as they did in 1994). However, this may only serve to delay DI and OASI reforms.

You can view a combined summary of the 2015 Social Security and Medicare Trustees reports at You can also access a full copy of the Social Security report from that page. You can find the full Medicare report at

Selling your home? Here’s the income tax facts

home for saleSummer is a time when many folks choose to move to a new home. It makes a lot of sense, especially if you have children in school – this way if the move is to a new school district, the children will not have to switch schools during the academic year.

Selling your home can have consequences for your income taxes. Recently the IRS issued their Summertime Tax Tip 2015-13, which details ten key tax facts about home sales. The text of the Tip is below:

Ten Key Tax Facts about Home Sales

In most cases, gains from sales are taxable. But did you know that if you sell your home, you may not have to pay taxes? Here are ten facts to keep in mind if you sell your home this year.

  1. Exclusion of Gain.  You may be able to exclude part or all of the gain from the sale of your home. This rule may apply if you meet the eligibility test. Parts of the test involve your ownership and use of the home. You must have owned and used it as your main home for at least two out of the five years before the date of sale.
  2. Exceptions May Apply.  There are exceptions to the ownership, use and other rules. One exception applies to persons with a disability. Another applies to certain members of the military. That rule includes certain government and Peace Corps workers. For more on this topic, see Publication 523, Selling Your Home.
  3. Exclusion Limit.  The most gain you can exclude from tax is $250,000. This limit is $500,000 for joint returns. The Net Investment Income Tax will not apply to the excluded gain.
  4. May Not Need to Report Sale.  If the gain is not taxable, you may not need to report the sale to the IRS on your tax return.
  5. When You Must Report the Sale.  You must report the sale on your tax return if you can’t exclude all or part of the gain. You must report the sale if you choose not to claim the exclusion. That’s also true if you get Form 1099-S, Proceeds From Real Estate Transactions. If you report the sale, you should review the Questions and Answers on the Net Investment Income Tax on
  6. Exclusion Frequency Limit.  Generally, you may exclude the gain from the sale of your main home only once every two years. Some exceptions may apply to this rule.
  7. Only a Main Home Qualifies.  If you own more than one home, you may only exclude the gain on the sale of your main home. Your main home usually is the home that you live in most of the time.
  8. First-time Homebuyer Credit.  If you claimed the first-time homebuyer credit when you bought the home, special rules apply to the sale. For more on those rules, see Publication 523.
  9. Home Sold at a Loss.  If you sell your main home at a loss, you can’t deduct the loss on your tax return.
  10. Report Your Address Change.  After you sell your home and move, update your address with the IRS. To do this, file Form 8822, Change of Address. You can find the address to send it to in the form’s instructions on page two. If you purchase health insurance through the Health Insurance Marketplace, you should also notify the Marketplace when you move out of the area covered by your current Marketplace plan.

401(k) Mistakes (also applies to other Retirement Plans!)

mistakeThese days you’re pretty much on your own when it comes to planning for your retirement. Granted, many state and local governments have a pension plan, but beyond that, precious few employers provide a pension these days. Typically retirement benefits only include a 401(k) or other deferred retirement plan, which means it’s up to you! For the purpose of brevity, I’ll refer to 401(k) plans throughout this article; please understand that most of the information applies to 403(b) plans, 401(a) plans, and 457 plans as well as Keogh, SIMPLE, and SEP IRA plans.

For most of us, the 401(k) is the default account that must take on the role that the pension plan did for previous generations. Paying attention to and avoiding the following mistakes can help you to ensure that you have a financially-secure future.

#1 – Choosing Not to Participate
It’s amazing how many folks, young or old, don’t participate in their company’s 401(k) plan. If your employer matches your contributions, you’re effectively giving money away. You wouldn’t do that with a raise or a tax cut, would you? And even if your employer doesn’t match your contributions, the tax savings should be enough to spark your interest… If you’re not presently participating in your company-offered 401(k) plan, bear in mind that time is your greatest ally when it comes to building up your savings. Starting early and making regular contributions to your account will have an enormous impact on the results when you’re ready to begin using these funds in retirement.

For example, if you only put $1,000 into your account at age 25, with a compound rate of return of 6%, by age 65 your account would be worth over $10,000. By the same token, if you’d waited until age 30 to make that $1,000 deposit, by age 65 it would only have grown to $7,600. That’s roughly a 30% difference only because you delayed for 5 years!

If you put $1,000 aside each year beginning at age 25, at the example 6% return when you reach age 65 this would have grown to $154,000+. And if you delay 5 years, the result is $111,000, a difference of $43,000 for your extra $5,000 of deposits.

#2 Not Having a Plan
Blindly allocating your investments can have significant consequences as well. I have reviewed retirement plans where the participant believed that they were doing the right thing by “diversifying” across every fund choice in their plan. This results in diversification all right, but doesn’t take into account the time horizon for the investment, your own risk tolerance, and other factors. And most importantly, the diversification is not necessarily among different types of assets, only among different funds in most cases.

An acquaintance, age 26, had a conservative portfolio of investments in his account – amounting to more than 80% in bonds and fixed instruments. At that age, even the most conservative of investment plans should have you above a 50% ratio in equities, in order to take advantage of long-term stock market returns. Granted, stocks are more volatile than bonds and fixed income investments, but with a longer time horizon, bonds and fixed income investments can barely keep up with inflation, let alone provide any measure of growth. In addition, the longer time horizon provides the time to ride out any “bumps” in the market that may take place.

It makes good sense to analyze your potential investment choices, consider your time horizon, your risk tolerance, and ultimately your investment “mix”, in order to create a plan for your investments that will carry you toward that holy grail of investment success – a fruitful retirement.

#3 Set It and Forget It
While we shouldn’t obsess over every single market move every single day, we also shouldn’t make our investment and contribution decisions once and then leave them for 20, 30 or 40 years. Over time, your various investments are going to grow at different rates, eventually causing one or more of your holdings to become overweighted (with regard to your planned “mix”).

I generally recommend reviewing your quarterly statements just to see how things are going in your account, and choose one of the quarters to make rebalancing moves annually as needed. These rebalancing moves don’t need to be done until one or more of your investments gets to a 5% or more variance from your plan.

#4 Taking Out a Loan
This falls into the category of things you *can* do but shouldn’t. Kinda like jumping off a cliff. What happens here is that your contribution program goes on hold as you pay back the loan, and if you don’t pay it back, you’ll owe tax and penalties. In addition, you’re paying back your tax-deferred fund with after-tax dollars, which will eventually be taxed again when you withdraw the funds at retirement. In only the most extreme of circumstances should you consider this kind of loan – honestly, you’ll regret it if you do it in most cases.

Strategies of Successful Investors

successFor a golfer looking to improve his game, it can be useful to study the top golfers’ strategies and methods. Investors can, in much the same way, learn from the “money masters”, the top group of the most successful investors. You might not have their resources or years of experience, but understanding their philosophies can help you in your own approach to investing.

Think Like an Owner, Not Like a Trader
This philosophy is as commonsense as the investor who is so famous for following it: Warren Buffett. Any list of the most successful investors of all time has to include the chairman of Berkshire Hathaway, and he’s typically at the top of the list. The Oracle of Omaha is well-known for his down-to-earth approach to sizing up investment opportunities.

Buffett invests in businesses however (not stocks), and prefers those with consistent earning power and little or no debt. He also looks at whether a company has an outstanding management team. Buffett attaches little importance to the market’s day-to-day fluctuations; he has been quoted as saying that he wouldn’t care if the market shut down completely for several years. However, he does pay attention to what he pays for a business; as a value investor, he may watch a company for years before deciding to buy. And when he buys, he makes a big play and plans to hang on to his investment for a long time.

Don’t Forget That Markets Can Be Irrational
George Soros feels that markets can be irrational. However, rather than dismissing the ups and downs, the founder of the legendary Quantum Fund made his reputation by exploiting macroeconomic movements. He once made more than $1 billion overnight when his hedge fund speculated on the devaluation of the British pound.

Soros believes in capitalizing on investing bubbles that occur when investors feed off one another’s emotions. He is known for making big bets on global investments, attempting to profit from both upward and downward market movements. Such a strategy can be tricky for an individual investor to follow. However, even a buy-and-hold investor should remember that market events may have as much to do with investor psychology as with fundamentals, and use that information to your advantage. You probably wouldn’t apply Soros’s philosophy in the same way he does, but nonetheless it can be a valuable lesson to remember.

Use What You know; Know What You Buy
During his 13-year tenure at Fidelity Investments’ Magellan Fund, Peter Lynch was one of the most successful mutual fund portfolio managers in history. He subsequently wrote two best-selling books for individual investors.

If you want to follow Lynch’s approach, stay on the alert for investing ideas drawn from your own experiences. His books contend that because of your job, your acquaintances, your shopping habits, your hobbies, or your geographic location, you may be able to spot up-and-coming companies before they attract attention from Wall Street. However, simply identifying a company you feel has great potential is only the first step. Lynch did thorough research into a company’s fundamentals and market to decide whether it was just a good idea or a good investment.

Lynch is a believer in finding unknown companies with the potential to become what he called “ten baggers” (companies that grow to 10 times their original price), preferably businesses that are fairly easy to understand.

Make Sure the Reward is Worth the Risk
Perhaps the best-known bond fund manager in history, the co-founder of PIMCO Bill Gross makes sure that if he takes greater risk – for example, by buying longer-term or emerging-market bounds – the return he expects is high enough to justify that additional risk. If it isn’t, he says, stick with lower returns from a more reliable investment. Because bonds have historically returned less than stocks and therefore suffer more from high inflation, he also focuses on maximizing real return (an investment’s return after inflation is taken into account).

Choose a Sound Strategy and Stick To It
Even though all these investors seem to have different approaches, in practice they’re more similar than they might appear. Each of their investing decisions has specific, well-thought-out reasons behind it. They rely on their own strategic thinking rather than blindly following market trends. And they understand their chosen investing disciplines well enough to apply them through good times and bad.

Work with your financial planner to determine a strategy that matches your financial goals, time horizon, and investing style.

IRAs: Roth or Traditional?

compareThe question comes up pretty often: when contributing to an IRA, should you choose the Roth or Traditional? I often approach this question in general with my recommended “Order of Contributions”:

  1. Contribute enough to your employer-provided retirement plan to get the company matching funds. So if your employer matches, for example, 50% of your first 5% of contributions to the plan, you should at least contribute 5% of your income to the plan in order to receive the matching funds.
  2. Maximize your contribution to a Roth IRA. For 2015 that is $5,500, or $6,500 if you are age 50 or older.
  3. Continue increasing your contribution to your employer-provided plan up to the annual maximum. So if you have more capacity to save after you’ve put 5% into your employer plan to get the matching dollars, and you’ve also contributed $5,500 (or $6,500) to your Roth IRA, you should increase the amount going into your employer plan. Increase this amount up to the annual limit if possible. For 2015 the annual limit for employee contributions to an employer plan like a 401(k) is $18,000 (plus a catch-up amount of $6,000 if you’re age 50 or older).

Beyond those three items if you have more capacity to save, you may want to consider college savings accounts or tax-efficient mutual funds in a taxable account among other choices.

But the question I was referring to is this: Which is better – a Roth or Traditional IRA?

The answer, as you might expect, is a fully-qualified “It depends”. The are several important factors to take into consideration.

If you were to compare the two types of accounts side-by-side, at first glance you’d think that it doesn’t make any difference which one you contribute to – especially if you assume that the tax rate will be the same in retirement (or distribution phase) as it was before retirement (or accumulation phase). This is because you’d be paying the same tax on the distribution of the Traditional IRA after the investment period, simply delayed, that you would pay on the Roth contribution, only this part is paid up-front.

Clear as mud, right? Let’s look at the following table to illustrate. I have purposely not included any increases in value, as we’ll get to that a bit later. In the example, we’re using a 20% ordinary income tax rate.

Each year we had $1,250 available to contribute to either a Traditional or a Roth. We had to pay tax on the Roth contribution each year, but we were able to make the whole contribution of $1,250, tax-deducted on our Traditional account.

What happens when we factor in growth in the account? The following table reflects the next step in our analysis, with each account growing at 10% per year, and the values are as of the end of the year:

If you subtract the tax from the Traditional balance, you come up with the same number as the Roth account, since there is no tax on the Roth account at distribution. So, although you pay more in taxes, you had more contributions to your account, so it all comes out in the wash.

So far, I’ve not come up with a convincing argument for a Roth or Traditional IRA. Let’s make another change to our table, by assuming that the tax rate in distribution increased to 25%, and that we remain at a 20% rate during accumulation. The following results come from that change:

As you can see, this results in a nearly $1,100 increase in taxes at distribution, making the Roth IRA the preferred option. Conversely, if the ordinary income tax rate is lower in distribution, the Traditional IRA is a better option.

There are some other factors that we could consider and run calculations on, but for the most part we’ve covered the important bases. Depending upon your own situation, one might be better than the other, and the reverse could be true in slightly different circumstances.

However, strictly going by the numbers the Roth IRA is preferred when the income tax rate is higher in retirement, and it’s at least as good as the Traditional IRA if the rates remain the same. If the numbers were the only differences between the two accounts, this is not a strong argument for the Roth, because you’re just making a gamble as to what will happen with tax rates in the future.

Thankfully, there are more factors to bear on the decision. In my book An IRA Owner’s Manual I point out three very good reasons to choose the Roth IRA over the Traditional IRA (excerpt below). With those factors in mind, and given that most folks have a generally pessimistic view of tax rate futures in the US, it seems that the Roth IRA is the better choice in nearly all situations.

Three Very Good Reasons to Choose
The Roth IRA Over the Trad IRA

  1. Roth IRA proceeds (when you are eligible to withdraw them, at or after age 59½) are tax free. That’s right, there is no tax on the contributions you put into the account and no tax on the earnings of the account. You paid tax on the contributions when you earned them, so in actuality there is no additional tax on these monies.
  2. There is no Required Minimum Distribution (RMD) rule for the Roth IRA during your lifetime. With the Trad IRA, at age 70½ you must begin withdrawing funds from the account, whether you need them or not. For some folks, this could be the biggest benefit of all with the Roth IRA.
  3. Funds contributed to your Roth IRA may be withdrawn at any time, for any reason, with no tax or penalty. Note that this only applies to annual contributions, not converted funds, and not the earnings on the funds. But the point is, you have access to your contributions as a sort of “emergency fund of last resort”. While this benefit could work against your long-term goals, it may come in handy at some point in the future.
  4. (a bonus!) A Roth IRA provides a method to maximize the money you pass along to your heirs: Since there’s never a tax on withdrawals, even by your heirs, the amount of money you have in your Roth IRA is passed on in full to your beneficiaries, without income taxation to reduce the amount they will eventually receive – estate tax could still apply though.

As illustrated, if you believe ordinary income tax rates will remain the same or increase in the future, the calculations work in favor of the Roth IRA.

529 Plan vs. Student Loan

college 529 years agoWhen planning for the cost of college for your children, often parents and grandparents think of the 529 plan due to the tax benefits. Almost ten years ago the 2006 Pension Protection Act made the tax treatment of 529 plan college savings instruments permanent.  This will be familiar ground for most, but perhaps parents of future college students need to a refresher.

It will always be cheaper to save for college than to pay for loans. If you’re in the position of most folks – with enough assets that you figure your child won’t be considered for financial aid – then it pays in spades to save now. If you saved $150 a month into a 529 plan for 10 years at 4% rate of return, you’d have just over $22,000 saved up. If, on the other hand, you didn’t save that money and had to borrow $22,000, paying it back over the same 10 year period at 6% interest would require monthly payments of $245 – $95 dollars a month more. If you got lucky and the rate on the loan was the same 4%, the payments would still be $224 a month, almost 50% more than the amount you could have been saving.

The best time to start is yesterday, so the best thing to do is don’t delay. If you started putting money into a 529 plan when your child was first born, accumulating $22,000 by the time the child is 18 only requires $70 per month, assuming 4% rate of return. Wait just five years (until the child is 5), that payment increases to $108 per month. Wait until your child is 13, when you have only five years left in order to accumulate $22,000, you’d need to make 529 plan contributions of more than $333 each month.

Choose the right plan. The differences between your choices for a 529 plan alone are mind-boggling. You can choose a 529 plan that is specific to your state, or one of a myriad of other choices. You can choose a pre-paid tuition plan, or a savings 529 plan (my choice is always the savings type of 529 plan). In addition you need to consider other options for savings as well, such as a Roth IRA. Some options may provide tax benefits, others may not, but this is a critical choice to make as you make your savings plan work for you.


canoeOne of the more unique types of retirement accounts is the Simplified Employee Pension IRA, or SEP IRA for short.  This plan is designed for self-employed folks, as well as for small businesses of any tax organization, whether a corporation (S corp or C corp), sole proprietorship, LLC, LLP, or partnership.

The primary benefit of this plan is that it’s simplified (as the name implies) and very little expense or paperwork is involved in the setup and administration of the plan.  The SEP becomes less beneficial when more employees are added. There are additional options available in other plans (such as a 401(k)) that may be more desirable to the business owner with more employees.

SEP IRAs have a completely different set of contribution limits from the other kinds of IRAs and retirement plans.  For example, in 2015, you can contribute up to $53,000 to a SEP IRA. That amount is limited to 20% of the net self-employment income, or 25% of wage income if the individual is an employee of the business.

The account for each participant is an IRA, just like any other IRA (other than the contribution limits mentioned above).  You’re allowed to invest in any valid investment security offered by the custodian, rollover the plan (upon termination of employment) and direct the plan to your heirs however you wish, just like any other IRA.

Money contributed to the plan is excluded from the income of the employee/participant upon contribution, and any growth in the account is tax-deferred until distribution.  At the distribution of the funds, the funds will be taxed as ordinary income.  Upon reaching age 59½ you can access the funds without penalty – otherwise, unless you meet one of the early distribution exceptions, there is a 10% penalty imposed in addition to the income tax on the distribution.  At age 70½ you will be required to begin taking minimum distributions from the account, just like any other IRA.

Additionally, a SEP IRA can be established up to the filing date for your business entity – as late as April 15 of the following year if you like.  This is different from a 401(k), for example, which must be established during the tax year.

Have You Saved Enough for Retirement?

winding roadOne of the reasons that retirement funding is a mystery to most folks is the uncertainty that comes with trying to determine how much is enough – enough savings set aside so that we don’t run out of money during retirement.

The answer to this question begins with an understanding of your day-to-day living expenses, and how those expenses may change in retirement. This is a simple enough process, although it does take some effort.

The difficult part is to determine what the funding requirement is in order to provide the income you’ll need to cover your living expenses – for as much as forty years or more!

There is a rule of thumb (more on this later) that you can use to come up with a rough guess – but without using sophisticated computer modeling and analysis, your level of assuredness is limited.

According to a recent survey by the Employee Benefits Research Institute, 84% of future retirees believe that they will have plenty of savings to cover their needs in retirement. At the same time, less than one-third of those surveyed had gone through the effort to calculate how much they will need.

When looking at the actual savings numbers, only around 20% of the survey respondents had in excess of $100,000 set aside for retirement, and more than 10% indicated that they had nothing at all saved for retirement.

The rule of thumb that I mentioned before indicates that you should plan to withdraw no more than 3% to 5% each year from your retirement savings in order to not run out of money. This is what we refer to as a “sustainable rate of withdrawal”. (There are many opinions about what exactly is the appropriate sustainable withdrawal rate – at one time it was suggested that 4% is the right number, but this has been under considerable scrutiny of late. Working with the range of 3 to 5% will get you in the ballpark, nonetheless.) This equates to a requirement of $1 million in retirement funds in order to be able to withdraw $30,000 to $50,000 each year.

Don’t despair over these estimates, though. The rule of thumb is based upon 100 percent certainty, and if you happen to have that luxury, that’s fantastic. There are ways to increase your sustainable rate of withdrawal, while still maintaining a relatively high degree of certainty.

Improving the Level of Certainty

The first and possibly most important factor is to have a plan, and to monitor your plan closely. You can do this on your own, or in conjunction with a financial pro. Paying close attention to your plan and staying with it will provide you with the information in order to make certain that your plan stays on track.

Your plan should include some sort of projections or modeling to show what your future income could be based upon your sources of income – retirement savings, pensions, Social Security, and the like. This will help you to plan for your expenses in retirement – developing a budget in reverse, if you will.

Making adjustments to your portfolio holdings can have a positive impact on the level of sustainable withdrawal. It may seem to run counter to your intuition, but more risk in your holdings is good for your long-term holdings. It is important to maintain significant positions in the stock market in order to achieve a higher level of withdrawals over time. Without some exposure to risk, your funds will fall behind when compared to inflation of day-to-day expenses, not to mention high-inflation items like healthcare costs.

The third factor that can have an impact on your savings’ sustainability is the pattern of income that you’ll need in retirement. As you probably realize, over the span of the potential forty-plus year retirement, your income needs will likely change. During your first several years, you’re likely to spend considerably more than the overall average, as you travel more, take on new hobbies, and the like. Or, on the other hand you may continue to save during this time of your life.

Later on in your retirement, many folks take on lower expenses as they become more sedentary, not traveling as much and having fewer extraneous expenses. Declining health and lower energy level makes staying closer to home more attractive. In later years, health care costs can cause those expenses to increase. It is also important to maintain a realistic view of your own life span. It’s not at all unreasonable to project your retirement plan out to your late 90’s.

There are more factors that can have a positive impact on your sustainable withdrawal rate, but these are the primary ones. I want to reiterate that the most important factor is to make a plan, monitor it closely, and make the appropriate adjustments throughout your life.

What you’ll find is that, by putting some effort into developing a plan, you’ll have much more confidence in your ability to make your savings last. At the same time, if you find that you haven’t yet done enough, you have time to make adjustments in your efforts that will increase your odds.

Having made a plan, it’s also important to review and update it, on average once a year or so. This kind of review will leave you with the peace of mind that, in fact, you’re on track.

Delayed Retirement Credits for Social Security

these two dudes are delayingWhen you delay filing for your Social Security retirement benefit until after your Full Retirement Age (FRA), your future benefit increases due to a factor known as Delayed Retirement Credits, or DRCs. These credits accrue at the rate of 2/3% for each month of delay, which equates to 8% for every full year of delay.

It’s important to know a few facts about DRCs. For one – the delayed retirement credits are accumulative, not compounding. If your Full Retirement Age is 66 (if you were born between 1943 and 1954), you can accrue a full 32% in DRCs. This means that the amount of benefit that you would normally receive at FRA (which is your Primary Insurance Amount, or PIA) would be multiplied by 132% at your age 70. If your FRA is above age 66, your maximum delayed retirement credit is something less than 32% – as little as 24% if your FRA is 67.

Delayed retirement credits stop once you reach age 70, no matter when your Full Retirement Age is.

If you are delaying your benefit to achieve the delayed retirement credits and you die before reaching age 70, your DRCs stop at your death. Your surviving spouse will be eligible for a Survivor Benefit with delayed retirement credits as of the date of your death. Even if your spouse delays receiving the Survivor Benefit after your death, no more delayed retirement credits will accrue to that benefit.

For example, if you died at the age of 68 years and 6 months, your surviving spouse will be eligible for a Survivor Benefit that is 120% of your Primary Insurance Amount (PIA). If your PIA is $1,500 that means your surviving spouse is eligible for a benefit equal to $1,800.

The same is true if you decide at some point before your own age 70 to go ahead and file. I get this question every once in a while, since most examples of File & Suspend illustrate the individual doing a file & suspend at Full Retirement Age and then delaying benefits until age 70. But it’s not a requirement that you delay until age 70 – if you delay until, for example, age 67, you’ll achieve an increase of 8% since you waited a year before filing for your benefit.

You can file at any time after you’ve reached Full Retirement Age to achieve this 2/3% increase for each month. There’s no requirement to File & Suspend before filing for the delay credits either. It might be part of your strategy to File & Suspend if you’re delaying your own benefit but want to provide a Spousal Benefit for your better half. On the other hand, you might not want to File & Suspend if you plan to file a restricted application for Spousal Benefits based upon your spouse’s record.

Lastly, DRCs only affect your own retirement benefit. There are no delayed retirement credits for Spousal or Survivor benefits by delaying past FRA.

The Second Most Important Factor to Investing Success

Photo courtesy of Padurariu Alexandru via

Photo courtesy of Padurariu Alexandru via

On these very pages not too long ago, I pointed out the most important factor to achieving investing success, which is consistent accumulation. The second most important factor? Asset allocation.

Asset allocation is the process of dividing your investment “pile” into various different types of investments in an effort to maximize your exposure to the unique benefits of each type of asset class – while at the same time utilizing the risk as efficiently as possible.

When it comes to asset allocation, there are two primary factors which help to determine how you might allocate your investment assets: risk tolerance and time horizon.

Risk tolerance deals with whether or not you can sleep at night knowing that your investment could fall (or rise!) by 15%, for example. If you’re a person who feels compelled to monitor your investments every day and can’t stand it when you see a loss, you have a low tolerance for risk. If, however you recognize that it is important to take measured risks in order to achieve a better return, you may have a moderate tolerance for risk. On the third hand, if you consider the lottery, Texas Hold ‘Em, and day-trading penny stocks to be reasonable components of a portfolio, you may have an inappropriately large appetite for risk.

Risk is tempered by your time horizon. In other words, even if you’re fairly risk-averse, if your time horizon is long enough, you can (and should) take on a fairly risky allocation model. Conversely, when your time horizon is shorter, you may need to dial down the risk – even if you have a relatively high appetite for risk – the short time horizon reduces your ability to recover from significant losses should they occur.

What’s important to remember is that investing too conservatively early on in your savings career can have a drastic affect on the results. Since you have a significant amount of time for compounding to work in your favor, it makes sense to take additional risk to increase the overall return for your portfolio. With time on your side, you can afford to take a little more risk when the reward is appropriate.

At the same time, when your investing horizon is shorter, say less than five years, you can’t afford to put your funds at much risk. But this doesn’t mean that you should put your money under the mattress – inflation will eat away the buying power of your money in a short time. It’s important to maintain a degree of risk in your portfolio throughout your investing life in order to combat the impact of inflation and provide for a minimal amount of growth.

Once you determine an appropriate allocation model to follow, it makes sense to review and re-balance your portfolio about once a year – in order to make sure your allocation model is still in effect. Rebalancing more often doesn’t produce benefits to match the amount of effort and transaction costs that you would incur.

Divorcee Social Security Planning

divorcedIf you’re planning to retire and you’re a divorcee, you may be entitled to additional retirement benefits based on your ex’s earnings record.

This can be quite a boon for an individual whose ex-spouse has had a significant earnings record over his or her lifetime. Especially so, if your own benefit is lower because you didn’t work outside the home for a significant number of years.

You may be eligible for this additional benefit if you are at least age 62, your marriage lasted for at least ten years, and your ex-spouse is at least 62 years of age (and therefore eligible for Social Security benefits). If your ex hasn’t filed for his or her own Social Security benefit, the last factor is that your divorce must have been final for at least two years. If your ex has filed for benefits, this time limit is eliminated.

How Can You Plan?

So you’ve determined that as a divorcee you’re eligible for a Spousal Benefit based on your ex’s record. How can you plan? How can you determine what amount of Spousal Benefit you may have available?

Of course, a quick and easy way to know how much your Spousal Benefit might be is to ask your ex-spouse. He or she should know (or should be able to find out readily) the amount of Social Security benefits that he or she will have coming upon retirement.

But it’s often not so easy – naturally a product of divorce is a cut-off of communications, by either or both parties. Even if communicating is possible, it may be far from the desirable choice. The good news is that you don’t *have* to do it that way. You can just go to the Social Security Administration office near you to find out.

But wait a minute – you’d at least hope that the SSA folks wouldn’t just hand out personal information to just anyone who darkens their threshold, right? I mean, you can’t just walk in and ask for Social Security benefit information for another person’s record without proving that you *should* have access to this information.

Of course, there is a certain amount of information that the Social Security Administration staff will not give you – your ex’s Social Security number and address, for example. But if you prove your relationship to the ex – that is, if you can show evidence that you were married for the applicable 10 years or more, and that you are divorced – you can get some information for planning purposes.

This evidence is in the form of a marriage license and a divorce decree. Both items must be official records. In addition, if you don’t have your ex’s Social Security number, you will have to provide enough identifying information to ensure that the records requested are the appropriate ones. This identifying information includes full name, including maiden name if applicable, date of birth, place of birth, known addresses, parents’ names and addresses, and possibly other information to correctly identify your ex.

Once the record has been identified and your relationship the the individual is established, SSA may give you access to your ex’s:

  • Primary Insurance Amount (PIA) – for use in determining what your future Spousal and Survivor Benefits might be;
  • Earnings Record – for use if you believe that the PIA may be incorrect due to incorrect information in the earnings record, to pursue review of earnings record discrepancies.

Generally with the information specified above these inquiries can be made over the telephone, although in certain situations a request must be made in person.

Why Financial Planning?

Photo courtesy of Sebastien Gabriel via

Photo courtesy of Sebastien Gabriel via

I am always advocating creating a plan for your financial life – but why plan? Maybe we can identify some factors which may motivate you to develop plans for your life, incorporating financial factors with the rest of your life.

Following are some of the more important factors that you may want to think about:

  1. It is a way to prepare for the inevitable future. This fits in with one definition of planning, which is “intelligent cooperation with the inevitable.”
  2. Planning identifies problems and points the way to solutions. Taking a systematic, thorough look at the situation and thinking about the future possibilities can bring these things to light.
  3. It helps us to do first things first. In other words, it provides a rationale for assigning priorities. Should we save more for retirement, or for college? Should we pay off our home mortgage?
  4. Planning helps to coordinate your various goals with one another. For example, you need to make sure that adequate funds are being set aside for family vacations, while still putting aside funds for college and retirement.
  5. Planning can educate, involve and inform you and your family about the various goals and situations that you have to account for within your financial world. Planning can be a real eye-opener.

Now, just so that you won’t think that this concept of planning is a new idea, I recently came across the following endorsement of the concept of planning:

Suppose one of you wants to build a tower. Will he not first sit down and estimate the cost to see if he has enough money to complete it? For if he lays the foundation and is not able to finish it, everyone who sees it will ridicule him, saying ‘this fellow began to build and was not able to finish.’

Or suppose a king is about to go to war against another king. Will he not first sit down and consider whether he is able with ten thousand men to oppose the one coming against him with twenty thousand? If he is not able, he will send a delegation while the other is still a long way off and will ask for terms of peace.

In case you don’t recognize the quote, it is from the New Testament of the Bible (NIV), the book of Luke, chapter 14, verses 28-32. Obviously the concept of planning is important – considered by Jesus Christ to be what we call today a “no brainer”. That’s a pretty powerful endorsement, in my opinion.

Hopefully these factors have helped you to understand the importance of planning – and that you are inspired to begin developing your own plan. Because your life will go according to “a” plan, you might as well make it “your” plan!

Credit for Reduced Social Security Benefits When Subject to the Earnings Test

earningsContinuing to work while receiving Social Security benefits may cause a reduction to your benefit – if you earn more than the annual earnings test (AET) amount. But this reduction isn’t permanent – you will get credit for reduced Social Security benefits when you reach Full Retirement Age. So how does this work?

Earnings Test

The earnings test limit is $15,720 for 2015 if you are under Full Retirement Age for the entire year. The limit is $41,880 in the year that you reach Full Retirement Age. Full Retirement Age (FRA) is age 66 if you were born between 1946 and 1954, ratcheting up to age 67 if your birth year is 1960 or later.

So for 2015 if you were born after 1949 and you are receiving Social Security benefits, for every two dollars that you earn over $15,720, one dollar of your benefit is withheld.

For example, if you earn $20,000 in 2015 and your Social Security benefit is $500 per month, that’s $4,280 more than the limit. Your $500 benefit will be withheld for the first 5 months, in order to withhold the full $2,140. The extra $360 will be refunded to you at the beginning of the next calendar year.

The same would happen if you will reach FRA in 2015 and you earn more than $41,880. Let’s say you make $50,000 during the first half of 2015 and you reach age 66 on July 1. Since you’ve earned $8,120 more than the limit before reaching FRA, $1 is withheld for every $3 over the limit. So if your SS benefit is $1,000, in order to withhold $2,707, 3 months’ worth of benefits will be withheld.

The Payback

Once you reach Full Retirement Age, you will receive credit for reduced Social Security benefits. SSA will look at your record to determine how many months’ worth of benefits that you have had withheld due to the earnings test. Your filing age is then re-calculated, adding on those months of withheld benefits.

Returning to our example from above, you were receiving a benefit of $500 per month beginning at age 62, and over the years 15 months’ worth of benefits had been withheld due to the earnings test. At FRA, your filing age is re-calculated as if you had filed at the age of 63 years, 3 months – an addition of 15 months.

Since your original benefit was reduced by 25%, your re-calculated benefit would only be reduced by 18.33% – owing to the fact that the year between age 62 and 63 increases your benefit by 5%, and each month above 63 increases the benefit by 5/9%, a total of 15/9%, or 1.67% total. So your $500 benefit is increased to $544 per month from now forward.


This reduction and payback applies to your own retirement benefit, spousal benefits, and survivor benefits. If your own benefit is withheld due to earnings over the limit, your beneficiaries’ benefits (your spouse’s or children’s benefits) will also be withheld until the reduction amount is completely covered. If you are receiving spousal benefits before FRA and are also working and earning more than the limit, only your spousal benefit is reduced due to those earnings.

Will Work After Retirement Age Increase My Social Security Benefit?

work after retirement ageThis question comes up every once in a while: Will work after retirement age increase my Social Security benefit due to the additional earnings going on my record?

The answer, as with many of these calculation-type questions, is a fully-qualified “maybe”. The amount of your earnings from work in any year may have a positive impact on your benefit – not just work after retirement age. On the downside, depending upon your benefit amount it may not be much of an increase.

The reason it’s not certain whether work after retirement age will increase your benefit is because of the nature of the calculations involved. If you’ll recall from the article on calculation of your Primary Insurance Amount (PIA) – the foundation of this calculation is a figure called your Average Indexed Monthly Earnings, or AIME. The AIME is an average of the 35 highest indexed earnings years in your working life. This is (first) calculated based upon the years between your age 20 and the year before you reach age 60.

For example, if you reach age 62 in 2015, your AIME is first calculated based on your earnings between the years 1973 and 2013. The index is based on the average of all earnings for the years prior to 2014, as compared to the average of all earnings in the year 2013. For the year 1973 in this example, the indexing figure (multiplier) is 5.9217958 – so if your earnings in 1973 were $10,000 then the indexed earnings for that year would be $59,217. Each year of earnings is multiplied by the unique index factor for your year of eligibility.

Once these figures have been determined, any years of earnings on your record at or after age 60 are added to the list as well – but earnings at or after age 60 are not indexed. These are added to the list of your lifetime earnings at face value.

Once the list of your indexed years of earnings is compiled, the amounts, indexed and face value for those after age 60, are compared and the highest 35 years are selected. This list of 35 years of earnings is then totaled and divided by 420, the number of months in 35 years – and the result is your AIME.

Armed with your AIME, you can now calculate your Primary Insurance Amount (PIA). (PIA is the foundation of all benefit calculations based on your record. PIA is the amount of benefit you would receive if you file at exactly your Full Retirement Age.)

The PIA is based upon your first year of eligibility for benefits, the year in which you reach age 62. From the year you reach age 62, income levels called bend points are defined. For our example of an individual reaching age 62 in 2015, the amount of the AIME up to $826 is multiplied by 90%; for any amount above $826 up to $4,980, the amount is multiplied by 32%; and any amount above $4,980 is multiplied by 15%. (The dollar amounts are adjusted annually, the percentages remain the same.) These three results are added together, resulting in your PIA.

So – back to the question: Will work after retirement age increase my benefit due to the additional earnings?

After the initial computation (described above), in any subsequent year that you have earnings from a Social Security-covered job, SSA takes your additional earnings and puts them into the list of years of earnings (indexed prior to age 60, face-value thereafter) and determines if the additional year’s earnings is one of the highest 35 years in your list. If this additional year replaces a lower earning year in your original list, a new AIME is calculated. Then your same bend points from your age 62 year are applied and a new PIA is developed. This recalculation is automatic, you don’t have to do anything to have the new earnings applied.


John has been working all of his adult life, from age 20 onward. He will reach age 62 in 2015. His AIME has been calculated as $5,000 this year, which results in a PIA of $2,075.70.

John continues to work past his age 62 since he has risen to the position of manager at his job and he’s just not ready to retire. John’s total earnings are $90,000 in 2015. So at the end of 2015, SSA includes the 2015 earnings in his AIME calculation. His lowest indexed earnings from prior years was $59,217 – and this amount is replaced in his “high 35” with his earnings from 2015. This results in an increase to his AIME to $5,073, and then the PIA is recalculated as $2086.60.

So – indeed, if your additional earnings are greater than one of your AIME calculation years, earning more past age 62 can have a positive impact on your benefit. However, as illustrated in the example, adding a relatively high earnings year after age 62 only increased the PIA by $10.90 per month.

Adjusting the example – if John’s earnings for 2015 are only $40,000 – this amount is less than the lowest indexed amount in his AIME list, so the AIME is not recalculated, and neither is his PIA. This is good news if you think about it. Additional earnings can only increase your benefit and cannot decrease the benefit.

If your benefit is low by comparison to the bend points for your situation as a result of low or zero earnings in one or more years used in your calculation, work after retirement age may have a larger impact.

Looking at another example, Sam (age 62 in 2015) didn’t work outside the home for the first 18 years after he reached age 20, pursuing his recording career and raising his children. From age 38 on, he dropped the recording career dream and took on a job in customer service, earning an average indexed wage over the 23 years (from age 38 to 61) of $24,000 per year. However, since Sam had many years of zero earnings in his list, his AIME is calculated as $1,314 – and his PIA is calculated as $899.40.

If Sam earns his average salary of $24,000 in 2015, his AIME will be recalculated because those earnings replace an earlier “zero” year in his list. As a result his new AIME is $1,371, and the resulting PIA is $917.70. This is an increase of $18.30 per month, almost double the amount that John’s PIA increased for earning nearly four times as much in 2015.

Social Security Earnings Test

testWhen you’re receiving Social Security benefits before your Full Retirement Age (FRA, which is age 66 ranging up to age 67 for folks born in 1960 or later), there is an earnings test which can reduce or eliminate the benefit you are planning to receive.

If your earned income* is greater than $15,720 (2015 figure), for every $2 over this limit, $1 will be withheld from your Social Security benefit. So, for example, if you earn $20,000 in 2015, a total of $2,140 in benefits will be withheld – 50% of the over-earned amount of $4,280.

If you are receiving a Social Security benefit of $1,070 per month, this means that 2 months’ worth of benefits will be withheld. This can come as a surprise if you’ve been receiving the full benefit and the earnings test is applied at the beginning of the following year, when you don’t receive a check for two months.

After you reach FRA, you’ll get an adjustment to your benefit for the withheld checks. From our example, if you had two months’ worth of benefits withheld during the 3 years before the year you’ll reach FRA, you will receive credit for the months of withheld benefits. At FRA your benefit will be adjusted as if you had filed 6 months (3 years times 2 months) later than you actually filed. So if you originally filed at age 62, your benefit will be adjusted as if you filed at 62 years and 6 months, an increase of 2.5%.

In the year that you reach FRA (but before you actually turn 66) the earnings test is much more liberal: the limit is $41,880. Plus the rule is that for every $3 over the limit, $1 is withheld from your benefits. The rule is actually applied on a monthly basis, at the rate of $3,490 per month for partial years ($1,310 for the years before you reach FRA).

*So what earnings are counted? Only earnings from employment or self-employment are counted toward the earnings tests. There is a rather long list of income types that do not count toward the earnings test – here’s a brief rundown of non-counted earnings (only for Social Security earnings test, not for income taxation):

  • deferred income (based on services performed before becoming entitled to Social Security benefits)
  • court awards, including back-pay from an employer
  • disability insurance payments
  • pensions
  • retirement pay
  • real estate rental income (if not considered self-employment, i.e., the individual did not materially participate in the production of the income)
  • interest and dividends
  • capital gains
  • worker’s compensation or unemployment benefits
  • jury duty pay
  • reimbursed travel or moving expenses as an employee
  • royalties – only exempted in the year you will reach FRA, otherwise royalties are counted toward the earnings test

Social Security Survivor Benefit Coordination

coordinatingIf you’re a widow or widower and you are eligible for Social Security Survivor’s Benefits based on your late spouse’s record, you may have some timing decisions to make that could significantly affect your overall benefits. This is especially true if you are also eligible for Social Security benefits based on your own earnings record.

Timing the receipt of benefits is, as with most all Social Security benefits, the primary factor that you can control.  If you have worked over your lifetime and you have a  becomes even more important. The decision process is dependent upon the relative size of your own Social Security benefit as compared to the Survivor Benefit based on your late spouse’s record.

Own SS Benefit Greater than Survivor Benefit  If your own benefit will be greater than the Survivor Benefit, it could be beneficial to you in the long run to take the Survivor Benefit as early as possible (as early as age 60) even though it will be reduced.  You could then continue receiving this reduced benefit for several years to your FRA (or even to age 70) and then switch over to your own benefit, which will be higher and unreduced at that point.

Survivor Benefit Greater than Own Benefit  If the Survivor Benefit is the larger of the two, you could take your own benefit early (reduced, of course) and then switch over to the Survivor Benefit later, at FRA. It doesn’t pay to delay the Survivor Benefit to a date later than your Full Retirement Age – the Survivor Benefit will not increase after that age.

By using one of these methods you are able to receive *some* benefit earlier-on in your life, and then switch over to the higher benefit later.  Just keep in mind that earnings limits and other reductions will apply.  Also, these same options are available for ex-spouse widows and widowers as well, as long as you haven’t remarried prior to age 60.

Complications with Social Security Filing for Divorcees

divorceSocial Security filing decisions are tough enough – and so is being divorced. Add the two together and you have all sorts of complications. In this article we’ll review one type of complication with Social Security filing for divorcees that can work in your favor and one that can work against you.

Let’s start with the provision that may work against you – Deemed Filing.

Deemed Filing

When you file for benefits prior to Full Retirement Age (FRA, which is 66 for folks born between 1943 and 1954, ranging up to age 67 if born in 1960), a provision called “deemed filing” takes effect. Deemed filing means that you are “deemed” to have filed for all available benefits – generally meaning your own benefit and any spousal benefit that you are eligible for as of the date of filing.

The reason that deemed filing might work against you if you’re divorced is because of the nature of eligibility for spousal benefits for a divorcee: You are automatically eligible for spousal benefits based on your ex-spouse’s record when either the ex has reached age 62 and the divorce has been final for two years, or when the ex files for his or her own Social Security benefits, whichever occurs first.

For a currently-married individual, spousal benefits are not available until the spouse has applied for his or her own benefit. Because of this, the married individual has a bit more control over his or her filing for spousal benefits, since the couple can discuss and time the two filings in order to separate retirement benefits from spousal benefits. As a divorcee you have much less control over this decision.

For example, Lou divorced her husband Ed five years ago after a 10+ year marriage. Lou is going to reach age 62 this year, and she would like to file for her own benefit now, and then delay filing for the spousal benefit based on Ed’s record until she reaches FRA, age 66. The key here is Ed’s age. If Ed is already age 62 or older, Lou does not have the option of separating her retirement benefit from the spousal benefit.

On the other hand, if Ed reaches age 62 at least in the month after Lou reaches age 62, Lou could file for her own retirement benefit any time after she reaches age 62 but before Ed reaches age 62, effectively separating her own retirement benefit from the spousal benefit based on Ed’s record.

Another way that this separation could occur is if the divorce had not occurred more than 2 years before Lou’s reaching age 62, and Ed has not filed for his own benefit prior to Lou’s filing.

So in our example, if the divorce was only finalized earlier this year and Ed has not filed for his own benefit, Lou could file for her own retirement benefit separately from the spousal benefit any time before the two-year period after the divorce has elapsed – as long as Ed doesn’t file for his own benefit before that period has elapsed.

This is also dependant upon the fact that Lou remains unmarried. So another way to separate these benefits would be for Lou to re-marry, and then file for her own benefit at any time. The remarriage nullifies Lou’s eligibility for spousal benefits based on Ed’s record. The eligibility for spousal benefits based on Ed’s record is restored if Lou’s current marriage ends (either by a subsequent divorce or death of the current spouse) – but since she wasn’t eligible when she filed for her own benefit, deemed filing did not apply and she can control when she files for the spousal benefit.

Restricted Application

On the other hand, as a divorcee you may have special treatment available to you in filing a restricted application for spousal benefits.

The restricted application is an option where an individual can, at Full Retirement Age or later, file strictly for spousal benefits only while delaying filing on his or her own retirement benefit until later when delayed retirement credits have accrued. He or she must not have filed for any Social Security retirement benefits previously.

In order for an individual to be eligible to file a restricted application, of course that person must be eligible for a spousal benefit. As a divorcee, the same rules that restricted you in the deemed filing section above have a tendency to liberate you at this stage. Since eligibility for spousal benefits is based only on the age of your ex-spouse and the time elapsed since the divorce was finalized, a unique situation is available. Both spouses could be eligible to file a restricted application.

On the other hand, for a married couple only one spouse can be eligible for a restricted application – because eligibility for spousal benefits for married persons depends on the other spouse filing for his or her own benefit. In doing so, of course this person could not file a restricted application.

Back to our example couple, Lou & Ed: Lou chose not to file for her own benefit at 62, and Ed delayed as well. When Lou reaches FRA (as long as she’s unmarried), she can file a restricted application for spousal benefits based on Ed’s record. This is because she is at or older than FRA and she is eligible for spousal benefits due to the fact that her divorce has been finalized for more than 2 years and Ed is at least age 62. Ed’s filing status doesn’t matter to her eligibility.