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Fixing Social Security

social securityFor quite a while now we’ve been reading the reports from the Social Security Administration’s reviews of the status of the trust fund – where the prediction is that we’ll end up in the year 2033 with only enough money to pay 77¢ on the dollar of the promised benefits from Social Security. So far this revelation has not resulted in policymakers’ taking any actual steps to fix things, but sometime someone has to act. What can be done about fixing Social Security?

What Can We Do About Fixing Social Security?

As future recipients of benefits, we have some actions we can take to reduce our reliance on Social Security benefits. This won’t fix the problem with the underfunding of the system, but it may help your own situation.

Push for pensions.  As workers, we may have some power to push our employers to consider offering pensions again. It can be a cost tradeoff for the employer versus the cost of other benefits, but a pension could be an attractive feature to assist with employee retention. It may sound impossible, but it has happened recently with state workers in Connecticut.

Increase other retirement savings. Maxing out your 401(k) contributions and choosing proper investment diversification is one good way to supplement a dwindling or reduced Social Security benefit. You can also make contributions to a Roth IRA (within limits) and make non-deductible contributions to your 401(k) of some significant amounts (see A New Way to Fund Your Roth IRA).

What Policy Changes Can Be Enacted for Fixing Social Security?

As you might expect, there are plenty of actions that can be taken by Congress to fix the problem. Listed below are just a few that, while they’re tough-love-type actions, could resolve the problem with Social Security’s underfunding more or less permanently.

Eliminate the earnings cap. Presently only a certain amount of annual earnings is subject to Social Security taxation, unlike Medicare taxation which has no limit. For 2015 this limit is $118,500 ($117,000 in 2014) – any earnings above that limit are not subject to the combined 12.4% (employer and employee) Social Security tax. Eliminating this limit or cap would result in a significant amount of additional funds added to the Social Security tax revenues annually. Presently this cap covers approximately 83% of all earnings – leaving up to 17% of all earnings untaxed.

Increase the tax rate. Currently the Social Security tax rate is 12.4% on applicable earnings (as explained above). This is 6.2% from the employee’s gross pay, and a complementary 6.2% from the employer. Any increase in this tax rate would improve the trust fund as well.

Means testing. For folks with significant other sources of retirement income, Social Security benefits could be reduced or eliminated. After all, this is a social insurance program, intended to provide benefits to folks who have insufficient means to provide for themselves. It’s frustrating that saving for yourself might put you in a position to receive reduced benefits, but that’s just the sort of tough decisions that we as a society have to make.

Increase retirement age. This has been done before, and likely will be done again sometime in the future. In 1983 the “normal” retirement age for Social Security was raised from 65 to 66 for folks born between 1943 and 1954, and up to age 67 for folks born in 1960 or later. It’s not out of the question to increase this normal retirement age another year gradually, up to age 68 for folks born in 1966 or later.

At the other end of the spectrum, the early retirement age has been 62 since the Social Security program was first put in place. Changing this age would likely result in some positives for the trust fund, but leaving it the same has the insidious result of providing even less benefits for folks who file early. If the normal retirement age was increased to 68, filing at 62 would result in reduction of 35% from your normal retirement benefit amount.

Conclusion

No matter what we do it won’t be pleasant. It’s never easy to give up something that you’ve been promised. The problem is that if we don’t do something about it, we’ll be certainly giving something up, estimated at 23% of benefits. It’s going to be interesting times in the coming 18 years – I hope we can get the folks in Congress to take action sooner rather than later. In the meantime, push for a pension from your employer, and max out your own savings… it’s all you can do at this point.

Safety with an Emergency Fund

scissors - don't run with theseToday’s message is about Safety – but not things like “don’t run with scissors” or “wait a half hour after eating to go swimming”. What we’re referring to is the old concept of having an emergency fund. The primary thing that you should take away from this Safety discussion is Peace Of Mind.

An emergency fund is a vital component of your overall financial toolkit. You should have 3 to 6 months’ worth of expenses set aside in a liquid, stable account, such as a bank passbook savings account or a money market account. By “liquid” we mean that the funds are easily valued and withdrawn as necessary. By “stable”, we mean that the funds are not at risk due to market volatility, but also that there is some return in the form of interest to the account, however small.

Why do you need an emergency fund? First of all, even though it may seem like your employment is stable – there are millions of your fellow Americans who would tell you that nothing is stable. Your employment can dramatically change from one day to the next. With an emergency account, you can face this situation with much more confidence. That’s not to say that you wouldn’t be seriously impacted by a layoff, but having an emergency fund will help to cushion the blow.

Secondly, if you’ve got an emergency fund available, the next time your car breaks down, or you need a new roof, or the washing machine shoots craps, or you need new tires – you won’t have to go into debt to pay for it. And don’t feel guilty about using the funds in the emergency account, that’s what they’re for. Just be sure that  1) it’s actually an emergency; and 2) you repay the funds you’ve used (with the funds that you would have used to pay off those credit cards!).

Actually an emergency – we listed a few things earlier, such as your car breaking down or the washing machine falling apart, that constitute those day-to-day emergencies that in the past you might have reached for the old credit card to handle. With your emergency fund you don’t have to run up your credit card on these things. That doesn’t mean you raid the emergency fund to pay for those new golf clubs (sorry, not an emergency!) or to get that perfect pair of Jimmy Choos (also not an emergency). This fund’s use should be limited to real emergencies – things that you have to make tough choices about, like if I only had money for food or this “thing”, what would I choose?

Repaying your emergency fund – after the emergency is over, in order to pay back the money in your emergency fund to prepare for the next emergency you may need to divert some of your retirement savings temporarily. This has a higher priority than retirement saving, since the existence of your emergency fund allows you to maintain peace of mind as well as to keep from running up credit card balances in day-to-day life.

A new way to fund your Roth IRA

Photo courtesy of lee Scott on unsplash.com

Photo courtesy of lee Scott on unsplash.com

As you plan and save for your retirement, it’s nice to have multiple types of taxation for your income sources. You may have a pension, Social Security, and a traditional IRA, all of which are taxed to some degree or another.  Adding to this list you might have a Roth IRA which generally will provide you with tax-free income in retirement. The problem with the Roth IRA is that you have some strict limits on the amounts that you can contribute, and typical Roth Conversion strategies are costly and complicated. With the recent pronouncement from the IRS in Notice 2014-54, there is a brand new, sanctioned method, to fund your Roth IRA.

Keep reading…

Financial Advice to Ignore, Even if it Comes From Your Mother!

mother and childrenListed below are a few time-honored maxims that we’ve all heard.  Perhaps we’ve even heard these from very trusted sources – like our Mothers.  As you’ll see, it’s not always good advice… In the interest of full disclosure, my own Mother did not give me any of this advice.  She tended to stay with the “wait an hour after eating to go swimming” variety of advice. One of my favorites was always given as I was leaving the house during my younger years: “Have fun. Behave!” I once pointed out to her the fallacy involved there but she didn’t see the humor. :-)  At any rate, those rules have served me well through the years – thanks, Mom!Keep reading…

You’ve still got time to avoid tax surprises

tax surpriseEven though there are only a few more weeks left in the calendar year, there are a few things that you can do to avoid some serious and consequential tax surprises come April next year.

The IRS recently published their Special Edition Tax Tip 2014-21 which details some of the steps you could take now to avoid these surprises.

Still Time to Act to Avoid Surprises at Tax-Time

Even though only a few months remain in 2014, you still have time to act so you aren’t surprised at tax-time next year. You should take steps to avoid owing more taxes or getting a larger refund than you expect. Here are some actions you can take to bring the taxes you pay in advance closer to what  you’ll owe when you file your tax return:

Keep reading…

Social Security Bend Points for 2015

bend pointAlong with the increases to the maximum wage base and the Cost-of-Living Adjustment (COLA) announced by the Social Security Administration, the 2015 bend points used to calculate both the Primary Insurance Amount (PIA) for Social Security benefits were announced as well. In addition, the Family Maximum Benefit (FMax) bend points for 2015 were also announced.

Keep reading…

2015 Contribution Limits for Retirement Plans

The IRS recently published the new contribution limits for various retirement plans for 2015.  These limits are indexed to inflation, and as such sometimes they do not increase much year over year, and sometimes they don’t increase at all. This year we saw a few increases for some contribution amounts, and the income limits increased for most types of accounts after virtually no changes to the contribution amounts in 2014.

Keep reading…

Social Security Wage Base Set for 2015

Photo courtesy of Ryan Tauss on unsplash.com

Photo courtesy of Ryan Tauss on unsplash.com

The Social Security Administration has set the maximum taxable wage base for 2015 at $118,500. This represents an increase of $1,500 over the 2014 wage base of $117,000, an increase of 1.28%.

Social Security COLA for 2015 Set at 1.7%

The Social Security Administration announced today that the annual automatic Cost Of Living Adjustment (COLA) for Social Security benefits in 2015 will be 1.7%. This is comparable to the 1.5% COLA for 2014, and is the 5th time in the past six years that the adjustment has been less than 2%. Look for more articles in the near future with details on earnings limits, bend points, and other factors affected by the COLA.

The Benefits of Financial Planning

If you’re wondering about whether or not you need to do some financial planning, either on your own, using resources on the internet, or by hiring a financial planner, you might want to know what the benefits of financial planning are.

From my perspective of many years providing financial planning and advice to folks, there are three primary benefits of financial planning: Organization, Efficiency, and Discipline. We’ll talk about each of these in order.

gears can help with organization in financial planningOrganization

One of the most important benefits of financial planning is ORGANIZATION. Statistics tell us that fewer than 25% of Americans know their financial net worth. In addition, (prepare to be astounded) the average individual’s credit card debt is over $8,000. Think about that for a moment…

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New For 2014 Taxes: Health Premium Tax Credit

premium tax credit could be used for drugsWe knew when Obamacare went into place that there would be new requirements for income tax filing, and one of the first to deal with is the health premium tax credit. This will require the use of a new form, Form 8962.

Health Premium Tax Credit

For this tax credit you will need to reconcile your advance credits that you have received in the form of reduced subsidized healthcare premiums.

Keep reading…

Understand Deemed Filing to Avoid a Surprise in Your SS Strategy

deemed filing?There’s nothing worse than feeling as if you have your Social Security filing strategy all lined out, when a rule like deemed filing rears its ugly head to throw your strategy off track.

Here’s an example: Steve and his wife Edie are ages 66 and 61 respectively. The plan is for Steve to file for his Social Security benefit now (at his Full Retirement Age), and for Edie to file for her own benefit when she reaches age 62. Then Edie will wait until she reaches Full Retirement Age of 66 to file for the Spousal Benefit based on Steve’s record, which will increase her benefit by $500 at that time.

Keep reading…

Yoda Would Suggest a Low-Cost Index

Use the low-cost index, Luke

“Use the low-cost index, Luke…”

Recently a colleague told me that he’d “give that a try”. I responded (tongue in cheek of course) “Try not. Do or do not. There is no try.”  In case you don’t recognize it, that’s a line that Yoda gives to Luke Skywalker in the Star Wars “Empire Strikes Back” movie. Yoda was pointing out to Luke that if he simply “tries” to undertake the action, he will not succeed. I think it shows that Yoda would also suggest a low-cost index mutual fund for investing.

If you think back to the excellent article that Sterling wrote a few weeks ago, “Not All Index Funds are Created Equal”, Sterling used a particular load mutual fund as an example. The objective of the fund (paraphrasing here):

Seeks to match the performance of the benchmark…

Let’s analyze that objective. The “benchmark” in question is an index, in particular the S&P 500 index. And the term “seeks” can be interpreted as “tries”. So the fund tries to match the performance of the S&P 500 index. It is the act of “trying” that causes costs to go up. All that “trying” by the fund manager(s) costs money after all – there are yachts to buy don’t you know?

So anyhow, if our objective as investors is to match the performance of the benchmark, why not invest in the benchmark via a low-cost index fund rather than in a fund that wastes a lot of effort (and money) “trying” to match the benchmark?

I think Yoda would heartily approve.

Ten Essential Tips for a Bright Financial Future

  1. bright financial futureSee a lawyer and make a Will. If you have a Will make sure it is current and valid in your home state. Make sure that you and your spouse have reviewed each other’s Will – ensuring that both of your wishes will be carried out. Provide for guardianship of minor children, and education and maintenance trusts. If you have divorced and remarried, make sure that your retirement account beneficiary designations are up-to-date reflecting your current situation.
  2. Pay off your credit cards. Forty percent of Americans carry an account balance on their credit cards or other personal credit – this is not good for your financial future. Create a systematic plan to pay down your balances. Don’t fall into the “0% balance transfer game” as it will hurt your FICO score. Credit scores matter not only to credit card companies but to insurance companies and future employers as well; you can avoid an unpleasant increase in your insurance rates by managing your credit wisely.
  3. Buy term life insurance equal to 6-8 times your annual income. This is primarily true for younger folks who have financial obligations to cover with future income. Most consumers don’t need a permanent policy (such as whole life or universal life). Also consider purchasing disability insurance; think of it as “paycheck insurance.” Stay-at-home spouses need life insurance, too! Note: Each family’s needs are different. Some families have a need for other kinds of life insurance, so you should review your situation carefully with an insurance professional (preferably two or more) before making decisions in this area.
  4. Build a 3 to 6 month emergency fund. This helps you to keep from having to charge up your credit cards when life’s emergencies strike. In the interim, before you’ve built up your fund, you can establish a home equity line of credit before you need it – this can take the place of part of your emergency fund.
  5. Don’t count on Social Security too much. Since the projections show that in the future the most that can be paid out for Social Security obligations is around 77%, you should adjust what you expect to receive – especially if you are age 50 or younger. Make up for this by funding your IRA each and every year. If you don’t fund these accounts annually, you lose the opportunity to increase your tax-deferred savings. Fund a Roth IRA over a traditional IRA if you qualify.
  6. If offered, contribute to your 401(k), 403(b) or other employer-sponsored saving plan. Just the same as with your IRA, if you don’t take advantage of the opportunity to defer funds into these savings vehicles, you lose the opportunity. In addition, if you don’t participate in the plan, you lose the chance to receive the matching funds from your employer.
  7. Use your company’s flex spending plan to leverage tax advantages. If you don’t use your flex plan annually, you lose the opportunity – and the tax advantages – for that year.
  8. Buy a home if you can afford it. Maintain it properly. Build equity in your property. You’ll have much more to show for your money spent than a box full of rental receipts! This is also about more than your financial future – studies show that home ownership adds to peace of mind and improved quality of life.
  9. Use broad market stock index funds to reduce risk and minimize costs. Indexes are a simple way to diversify, and they can have very low costs but you have to pay attention to make sure you’re getting a low-cost index. Diversification reduces risk of single securities (see #10) and reducing costs is one of the best things you can do to improve your overall investment results. If you have limited options, for example in your 401(k) plan, make sure that you diversify across a broad spectrum of options.
  10. Don’t over-weight in any one security, especially your employer’s stock. As a rule of thumb, keep exposure to any single stock to less than 5% of your overall portfolio. If you over-expose to a single stock and that company goes bankrupt, you’ve lost a significant portion of your portfolio. It can happen easily, history is littered with good companies that went bad.

Minimize taxes by adjusting your portfolio

minimize taxesSince the markets have had some downturns lately, now could be a good time to make some adjustments to your portfolio, rebalancing and the like, that may help to minimize taxes. In doing so you can possibly get a bit of advantage in your tax bill from a loss you’ve experienced in your investments.

If you have taxable accounts, that is, accounts that are not tax-deferred (like IRAs or 401(k) plans) when you sell your investments there is capital gains treatment on your gains and losses. If you have losses and gains in your taxable account, when you realize these losses and gains by selling the holdings, your losses are subtracted from the gains, and if the result is positive (net gains), these gains are taxed at the preferable long-term capital gains rates. I say this is preferable as the rate is less, often much less, than ordinary income tax rates.

Keep reading…

IRS Notice 2014-54: Will This Clarify NUA Basis Allocation?

ole-dog-300x245Recently the IRS issued a Notice, 2014-54, which details some information regarding the allocation of pre-tax funds from a qualified plan (such as a 401(k) plan) into a Roth IRA. This is a clarification of a question that has been on the minds of folks in the financial services industry for some time, and it’s a good result. Now the question becomes: does this help to clarify NUA basis allocation strategies?

If you’d like additional detail on Notice 2014-54, you can find the actual text of the Notice by clicking this link.

What I find interesting about this Notice is that this is the first time that the IRS has used this interpretation of the rules referenced specifically in IRC Section 402(c)(2), which is the code section I’ve referenced before regarding allocation of basis for Net Unrealized Appreciation (NUA) treatment for employer stock. (See more information in this most recent article NUA Allocation Twist – Not as Easy as it Looks.) The problem (outlined in the article) has been that plan administrators are unwilling to attempt applying the allocation of basis in an NUA transaction because there has never been any guidance from the IRS on such an allocation of basis. Notice 2014-54 may be the first step toward such guidance.

I’ve sent queries to the best minds I know in the retirement plan law universe to get additional insights into this concept – and as yet have not received a confirmation either way. I think this is a step in the right direction, but don’t get too excited yet.

I’ll keep you posted.

File & Suspend and Restricted Application are NOT Equal

spousal beneWe’ve discussed the Social Security filing options of File & Suspend and Restricted Application many times before, but it seems that folks continue to confuse these two options. It’s easy to see why: one (File & Suspend) can be used to enable the other (Restricted Application). Also, neither option is available until the individual is at least at Full Retirement Age (FRA). It’s important to know the difference between File & Suspend and Restricted Application though – primarily because if you confuse the two when talking to the Social Security folks, you’ll have a much different outcome than you expected and hoped for.

Let’s start by defining each option.  Keep reading…

Paper Social Security Statements are Back

The best laid schemes o’ mice an’ men
Gang aft agley

— Robert Burns
To a Mouse, on Turning Her Up in Her Nest with the Plough

Photo courtesy of Sylwia Bartyzel on unsplash.com

Photo courtesy of Sylwia Bartyzel on unsplash.com

As with many great ideas, in practice the concept of exclusive electronic delivery of Social Security benefit statements seems to have gone “agley”. Apparently a very small percentage of folks actually took advantage of the online version of these statements (primarily my client base, I’m guessing). As a result of this and apparent feedback from customers, advocates and Congress, Social Security is resuming the physical delivery of paper Social Security Statements.

The new delivery schedule will be based upon the age of the potential Social Security benefit recipient, with statements being sent automatically 3 months before your 25th, 30th, 35th, 40th, 45th, 50th, 55th, and 60th birthdays. You will only receive this statement if you are not currently receiving Social Security benefits AND if you have not registered with a mySocialSecurity account (the online statement portal).

You can still receive a Social Security statement from the online system at any time, as often as you wish. This is accomplished by going to the address www.socialsecurity.gov/myaccount. Just keep in mind that you will not receive a mailed paper Social Security statement thereafter once you’ve signed up. Online is the only method that you will be able to receive this statement once you’ve signed up, or once you’ve begun to receive benefits from Social Security.

Five-Step Reallocation

Since there’s been an appreciable run-up in stocks over the recent past, now may be a good time to reallocate your investment allocations in your retirement plans and other accounts. You’ve probably heard of reallocation before – but what does it really mean?

Reallocating is the process of changing your current mix of investments to a different mix. It could be that you’ve changed your risk assessment and wish to have more stock and fewer bonds, vice versa, or your investments have grown in some categories from your original allocation and you need to get the mix back to where you started.

At any rate, reallocation is a relatively simple operation, and research tells us that it is important to reallocate regularly, such as on an annual basis. Below are five steps that you can use for a simple reallocation in your accounts.

Keep reading…