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Dear Liz: Two years ago, I elected to start my Social Security benefits early, at age 62. My current benefit is $1,350 per month. My spouse, currently working, will be turning 62 next year and is also planning to take an early retirement benefit because of health issues. Her benefit is expected to be slightly more than my benefit at that time. If she dies before me, what can I expect to collect from Social Security as the spouse of someone who started benefits early?

Answer: If your wife dies before she begins receiving Social Security, your survivor’s benefit would be based on what’s known as her “primary insurance amount.” That’s the amount she would receive at full retirement age (which is 66 for those born between 1943 and 1954; after that, full retirement age increases gradually to age 67 for those born in 1960 or later).

Once she begins benefits, though, your survivor’s benefit is based on what she’s actually getting. So if she receives a reduced benefit, your survivor’s benefit is reduced as well. It would be further reduced if you, as a widower, begin taking survivor’s benefits before your own full retirement age.

You would not be able to get your own benefit plus a survivor’s benefit if your wife should die, by the way. You would get the larger of the two, but not both.

Categories : Q&A, Retirement
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Are Roths safer than other IRAs?

Jul 29, 2013 | | Comments Comments Off

Dear Liz: I found your recent discussion of Roth IRAs informative. But I’ve been told that one of the main advantages of a Roth vs. a traditional IRA is that a Roth is a safer investment when it comes to creditors trying to attack it. How can that be? Is one type of IRA safer than another?

Answer: The short answer is no.

Employer-sponsored retirement plans, including 401(k)s and 403(b)s, typically have unlimited protection from creditors in Bankruptcy Court. The exceptions: The IRS and former spouses can make claims on such plans.

Individual retirement accounts, including IRAs and Roth IRAs, lack the protection afforded by the Employee Retirement Income Security Act, or ERISA. But the bankruptcy reform law that went into effect in 2005 protects IRAs of all kinds up to a certain limit (which in April rose to $1,245,475).

Short of bankruptcy, the amount of your IRAs or Roth IRAs that creditors can access depends on state law.

If there’s any chance you’ll be filing for bankruptcy or the target of a creditor lawsuit, you should talk to an experienced bankruptcy attorney about your options.

Categories : Q&A, Retirement
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How much do you really need to retire?

Jul 29, 2013 | | Comments Comments Off

Dear Liz: None of the Web-based tools I’ve seen really get at the heart of the problem of how much I really need in retirement. For example, if I am diligent and save 20% of my income (I earn over $150,000), why would I need to replace 95% or even 80% of my income to maintain my standard of living in retirement? If I subtract the 20% going to savings, another 10% for the costs of working (clothes, lunches, gas) and reduce my income tax 5%, shouldn’t I be living the same lifestyle at 65% of my current income? Now, if I have a pension that will replace 10% of my pay, and if Social Security benefits for my spouse and me replace 30%, don’t my investments have to produce only the remaining 25%? Or am I missing something?

Answer: The further you are from retirement, the harder it can be to predict how much you’ll need when you get there.

Financial planners often use an income replacement rate of 70% to 80% as a starting point. It’s just that, though. Planners will tell you some of their clients’ spending actually increases in the early years of retirement as they travel and indulge in other expensive hobbies. Those who are frugal or used to living well below their means are often able to retire comfortably with a much lower income replacement rate.

A big wild card is the cost of medical and nursing care in your later years. The U.S. Bureau of Labor Statistics’ Consumer Expenditure Survey shows average overall spending tends to drop after retirement and continues to decline as people age. Serious illness or a nursing home bill can cause spending to surge late in life, however, leading to a U-shaped spending pattern for many.

Taxes also are hard to predict. While most people drop into a lower tax bracket once they stop working, those with substantial retirement incomes and investments may not. Tax rates themselves could rise in the future, even if your income doesn’t.

Social Security benefits may change, as well. Although it’s highly unlikely the program will disappear, some proposals for changing Social Security reduce checks for higher earners.

Once you’re within a decade or so of retirement, you should have a better handle on what you’ll spend once you quit work. Before that point, err on the side of caution. Assuming a higher income replacement rate gives you wiggle room once you’ve retired — or the option to retire earlier if it turns out you need less.

Categories : Q&A, Retirement
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Dear Liz: My partner passed away a little more than a year ago. I inherited his 401(k) and life insurance. I opened an IRA in which to place the amount of the 401(k), but the company told me that after a year (which is now), I have to withdraw the money over five years. Is that really required? I’d like to be able to have it on hand in case of an emergency but at the same time save it for our 2-year-old son’s college education.

Answer: Since you weren’t married, you don’t have the option of treating this inherited account as your own. That would have allowed you to delay withdrawals until after you turned 70 1/2 , if you wanted.

The fact that this is a non-spouse inherited IRA, however, doesn’t necessarily mean you’re bound by the five-year rule. That rule requires the IRA be distributed by Dec. 31 of the fifth year following the year of the original retirement account owner’s death. You may also have the option of beginning distributions based on your life expectancy. That would allow the bulk of the money to remain in the IRA, continuing to earn tax-deferred returns, and is usually a better choice.

Whether you have this second option depends on the terms of the IRA and the original 401(k) plan.

“It is important to check the IRA terms rather than rely on oral statements since the five-year option may be pushed when it is not required,” said Mark Luscombe, principal analyst for CCH Tax & Accounting North America. “It is also important to make a determination on the availability on the life-expectancy rule in the year after death since distributions must start under the life-expectancy rule in that year. Waiting too long could force one into the five-year rule by default.”

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How divorced people can get spousal benefits

Jul 22, 2013 | | Comments Comments Off

Dear Liz: I’ve been reading with interest your answers to questions about Social Security spousal benefits, particularly those available to divorced spouses. What if the former spouse is now remarried for more than 10 years, and the current spouse is receiving benefits? Are spousal benefits still available and how are they calculated?

Answer: The answer depends on whose earnings record we’re talking about, so a few pronouns might have helped clarify your question.

Let’s say you’re the earner. If your former spouse has remarried, then he is no longer eligible to receive spousal benefits based on your earnings record. Only divorced people whose marriages lasted 10 years and who are not married can get spousal benefits based on an ex’s earnings record.

If you’re the one hoping for spousal benefits, however, it doesn’t matter that your ex has remarried as long as you’re unmarried. Your ex’s current spouse and any previous spouses who qualify can receive spousal benefits. The amounts they get don’t affect any other spouse’s checks or the checks received by the earner (your ex).

Spousal benefits can be up to half the earner’s “primary insurance amount,” which is the check the earner would get if she started Social Security at full retirement age. The benefits are permanently discounted if the spouse or ex-spouse begins receiving them before his own full retirement age.

Categories : Q&A, Retirement
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Dear Liz: Everyone talks about Roth IRAs and how beneficial they are. But I am self-employed, my husband contributes 16% toward his 401(k), our house is paid off, and we no longer have dependents to deduct on our 1040 tax return. My contribution to my traditional IRA is the only tax deduction we have left. Should I consider a Roth anyway? If so, why?

Answer: A Roth would give you a tax-free bucket of money to spend in retirement. That would give you more flexibility to manage your tax bill than if all your money were in 401(k)s and traditional IRAs, where your withdrawals typically are taxable. Also, there are no minimum distribution requirements for a Roth. If you don’t need the money, you can pass it on to your heirs. Other retirement funds require you to start taking money out after you turn 701/2. If you need to crack into your nest egg early, on the other hand, you’ll face no penalties or taxes when you withdraw amounts equal to your original contributions.

So is it worth giving up your IRA tax deduction now to get those benefits? If you have a ton of money saved, you want to leave a legacy for your kids and you’re likely to be in the same or a higher tax bracket in retirement, the answer may be yes. If you’re like most people, though, your tax bracket will drop once you retire. That means you’d be giving up a valuable tax break now for a tax benefit that may be worth less in the future.

You may not have to make a choice, however, between tax breaks now and tax breaks later if you have more than $5,500 (the current annual IRA limit) to contribute. Since you’re self-employed, you may be able to put up to $51,000 in a tax-deductible Simplified Employee Pension or SEP-IRA. At the same time, you could contribute up to $5,500 to a Roth (assuming your income as a married couple is within or below the phase-out range for 2013 of $178,000 to $188,000).

This would be a great issue to discuss with a tax pro.

Categories : Q&A, Retirement
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Dear Liz: Many years ago I read about spousal benefits based on an ex-spouse’s Social Security earnings record. Is there a minimum length of time of the marriage to qualify? How do I apply for this benefit? I am within nine months of retirement.

Answer: You can qualify for Social Security spousal benefits based on an ex’s work record as long as:

•The marriage lasted 10 years or more.

•You are 62 or older and unmarried.

•Your ex-spouse is eligible to begin receiving his or her own Social Security benefit (even if he or she hasn’t applied yet).

•Your own benefit is less than the spousal benefit you would get based on his or her work record.

Any benefits you receive based on his or her record won’t affect what your ex receives, or what his or her current or other former spouses receive.

As with regular spousal benefits, the amount you get will be permanently discounted if you apply before you’ve reached your own full retirement age (which is currently 66 and will climb to 67 in a few years).

Categories : Q&A, Retirement
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Save or pay debt? Do both

Jul 01, 2013 | | Comments (4)

Dear Liz: I am a 67-year-old college instructor who plans to teach full time for at least eight more years. Last year I began collecting spousal benefits based on my ex-husband’s Social Security earnings record. Those benefits give me an extra $1,250 each month above my regular income. I have been using the money to pay down a home equity line of credit that I have on my condo. The credit line now has a balance of $29,000. I have about $200,000 in mutual funds and should have a small pension when I retire. (I went into teaching only a few years ago.) Would it be better for me to split the extra monthly $1,250 into investments as well as paying off my line of credit? The idea of having no loan on my condo appeals to me, but I wonder if I should try to invest in stocks and bonds instead.

Answer: Paying down debt is important, but opportunities to save in tax-advantaged retirement plans are typically more important. Fortunately, you probably have enough money to do both.

First investigate whether your college offers a 403(b) or other retirement program that offers a match. If it does, you should be contributing at least enough to that plan to get the full match.

Your next step is to explore an IRA. Since you’re covered by at least one retirement plan at work (your pension), you would be able to deduct a full IRA contribution only if your modified adjusted gross income as a single taxpayer is $59,000 or less in 2013. The ability to deduct a contribution phases out completely at $69,000.

If you can’t deduct your contribution, consider putting the money into a Roth IRA instead. Roth contributions aren’t deductible, but withdrawals in retirement are tax free. Having a bucket of tax-free money to draw upon in retirement can help you better manage your tax bill, which is why some investors opt to contribute to Roths even when they could get a deduction elsewhere.

People 50 and older can contribute up to $6,500 this year directly to a Roth if their income is under certain limits. (For singles, the limit for a full contribution is a modified adjusted gross income of $112,000 or less.) If your income is over the limit, you can contribute to a traditional IRA and then immediately convert the money into a Roth IRA, since there’s no income limit on conversions. (This is known as a “back door” Roth contribution.)

Since you’re so close to retirement, you don’t want to overdose on stocks, but you still need a significant amount of stock market exposure so that your money has a chance to offset future inflation. You might consider a balanced fund that invests 60% in stocks, 40% in bonds.

Once you’ve taken advantage of your retirement savings options, you can direct the rest of your Social Security benefit to paying off your home equity line. These credit lines typically have low but variable rates. Higher interest rates are likely in our future, so paying this line down over time is a prudent move.

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Dear Liz: You recently wrote that people who start Social Security benefits before their full retirement age are locked in and can’t switch to a higher benefit later. You are indeed locked in to that reduced benefit, but by switching to a spousal benefit at age 66, for example, it is possible to receive a higher benefit. Getting correct information about this is tough. I’m a certified financial planner and I received three different answers from Social Security personnel. Search the FAQ on the ssa.gov site for “receiving full and reduced benefits.”

Answer: Thanks for that important clarification. The original letter referenced a technique that some married couples can use to significantly boost their overall benefit. The technique allows people to start spousal benefits — Social Security payments based on the work record of a husband or wife — while letting their own benefit grow, to be claimed later. But the option of switching from the spousal benefit to your own benefit is available only if you start spousal benefits at your own full retirement age (which is currently 66). People who start spousal benefits before full retirement age can’t later switch to their own benefit.

As you note, however, people who start with their own benefit may be able to switch to a spousal benefit later. Both their own benefit and their spousal benefit would be reduced because of the early start. Here’s how Social Security explains it:

“When you apply for reduced retirement benefits, we will check to see if you are eligible for both your own retirement benefits and for benefits as a spouse. If you are eligible for both, we always pay your own benefits first. If you are due additional benefits, you will get a combination of benefits equaling the higher spouse’s benefit. If you are not eligible for both because your spouse is not yet entitled, but you are due a higher amount when he or she starts receiving Social Security benefits, then the higher spouse’s benefit is payable to you when your spouse applies for retirement benefits. Remember, you cannot receive spouse’s benefits until your spouse files for retirement.”

Social Security claiming strategies can be complicated. The AARP has an excellent guide at http://bit.ly/153Quvh.

Categories : Q&A, Retirement
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Dear Liz: My husband and I have been putting 5% and 6%, respectively, into our 401(k) accounts to get our full company matches. We’re also maxing out our Roth IRAs.

The CPA who does our taxes recommended that we put more money into our 401(k)s even if that would mean putting less into our Roth IRAs. We’re also expecting our first child, and our CPA said he doesn’t like 529 plans.

What’s your opinion on us increasing our 401(k)s by the amount we’d intended to put into a 529, while still maxing out our Roths, and then using our Roth contributions (not earnings) to pay for our child’s college (assuming he goes on to higher education)?

Our CPA liked that idea, but I can’t find anything online that says anyone else is doing things this way. I can’t help but wonder if there’s a catch.

Answer: Other people are indeed doing this, and there’s a big catch: You’d be using money for college that may do you a lot more good in retirement.

Contributions to Roth IRAs are, as you know, not tax deductible, but you can withdraw your contributions at any time without paying taxes or penalties. In retirement, your gains can be withdrawn tax free. Having money in tax-free as well as taxable and tax-deferred accounts gives you greater ability to control your tax bill in retirement.

Also, unlike other retirement accounts, you’re not required to start distributions after age 70 1/2. If you don’t need the money, you can continue to let it grow tax free and leave the whole thing to your heirs, if you want.

That’s a lot of flexibility to give up, and sucking out your contributions early will stunt how much more the accounts can grow.

You’d also miss out on the chance to let future returns help increase your college fund.

Let’s say you contribute $11,000 a year to your Roths ($5,500 each, the current limit). If you withdraw all your contributions after 18 years, you’d have $198,000 (any investment gains would stay in the account to avoid early-withdrawal fees).

Impressive, yes, but if you’d invested that money instead in a 529 and got 6% average annual returns, you could have $339,000. At 8%, the total is $411,000. That may be far more than you need — or it may not be, if you have more than one child or want to help with graduate school. With elite colleges costing $60,000 a year now and likely much more in the future, you may want all the growth you can get.

You didn’t say why your CPA doesn’t like 529s, but they’re a pretty good way for most families to save for college. Withdrawals are tax free when used for higher education and there is a huge array of plans to choose from, since every state except Wyoming offers at least one of these programs and most have multiple investment options.

Clearly, this is complicated, and you probably should run it past a certified financial planner or a CPA who has the personal financial specialist designation. Your CPA may be a great guy, but unless he’s had training in financial planning, he may not be a great choice for comprehensive financial advice.

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