Q&A: The confusing balancing act between government pensions and Social Security benefits

Dear Liz: I am a public school teacher and plan to retire with 25 years of service. I had previously worked and paid into Social Security for about 20 years. My spouse has paid into Social Security for over 30 years. Will I be penalized because I have not paid Social Security taxes while I’ve been teaching? Should my wife die before me, will I get survivor benefits, or will the windfall elimination act take that away? It’s so confusing!

Answer: It is confusing, but you should understand that the rules about windfall elimination (along with a related provision, the government pension offset) are not designed to take away from you a benefit that others get. Rather, the rules are set up so that people who get government pensions — which are typically more generous than Social Security — don’t wind up with significantly more money from Social Security than those who paid into the system their entire working lives.

Here’s how that can happen. Social Security benefits are progressive, which means they’re designed to replace a higher percentage of a lower-earner’s income than that of a higher earner. If you don’t pay into the system for many years — because you’re in a job that provides a government pension instead — your annual earnings for Social Security would be reported as zeros in those years. Social Security is based on your 35 highest-earning years, so all those zeros would make it look like you earned a lower (often much lower) lifetime income than you actually did. Without any adjustments, you would wind up with a bigger check from Social Security than someone who earned the same income in the private sector and paid much more in Social Security taxes. It was that inequity that caused Congress to create the windfall elimination provision several decades ago.

People who earn government pensions also could wind up with significantly more money when a spouse dies. If a couple receives two Social Security checks, the survivor gets the larger of the two when a spouse dies. The household doesn’t continue to receive both checks. Without the government pension offset, someone like you would get both a pension and a full survivor’s check. Again, that could leave you significantly better off than someone who had paid more into the system.

Friday’s need-to-know money news

Today’s top story: Making a habit of checking your financial health. Also in the news: Online business ideas for couch potatoes, how one couple paid off $20K of debt in 18 months, and how Trump’s tax plan may affect your 401(k).

Start a New Habit: Check Your Financial Health
Almost as important as your physical health.

3 Online Business Ideas for Couch Potatoes
Make money from your recliner.

How I Ditched Debt: Active Budgeting Pays Off
How one couple paid off $20,000 in 18 months.

How Trump’s tax plan may affect your 401(k)
Digging into the details.

Q&A: Social Security survivor benefits

Dear Liz: I have been with my significant other for over 30 years. We have an adult son. My significant other has a much larger Social Security benefit than I will have when it’s time for me to retire. I understand that if we were to marry and something happened to him, I would receive his benefit. But the law on Social Security is confusing. It says you have to be married several years to collect your spouse’s benefit unless you have a child. If we were married soon, would I be eligible for his benefits if something happened to him or would we have to be married for many years?

Answer: Social Security benefits can be confusing, but you don’t have to be married for many years to receive benefits.

To qualify for survivor benefits, you typically must have been married for at least nine months. To qualify for spousal benefits, you generally have to be married a year. If you have a natural child together and that child is a minor, the one-year requirement for spousal benefits is waived.

Survivor benefits are what you get when a higher-earning spouse dies. The benefit is 100% of what the deceased spouse received (or earned, if he hasn’t started benefits), but the amount is reduced if you as the surviving spouse begin benefits before your own full retirement age. The current full retirement age is 66 and will rise to 67 for people born in 1960 and later.

Spousal benefits are what you can receive while a spouse is still alive. This benefit is typically equal to half that spouse’s benefit and is reduced to reflect early starts.

You’ll need a longer marriage to get benefits should you divorce. The marriage must have lasted 10 years, and you must not be currently remarried to receive divorced spousal benefits based on your ex’s work record. For divorced survivor benefits, the marriage also must have lasted 10 years but you’re allowed to remarry at age 60 or later.

Thursday’s need-to-know money news

Today’s top story: The 4 perks of Solo 401(k) for business owners and freelancers. Also in the news: How to monitor your credit in exactly 250 words, how to eat healthy on a budget, and the best places to retire in 2017.

4 Perks of Solo 401(k) for Business Owners and Freelancers
Retirement savings for sole employees.

How to Monitor Credit in (Exactly) 250 Words
Short and sweet.

How to Eat Healthy on a Budget
You don’t have to live on ramen.

The Best Places To Retire In 2017
Where would you like to go?

Investment fees could leave you old and broke

You want to save as much as possible for retirement. The financial services industry wants to make as much money off you as it can.

That thorny conflict is at the heart of the battle over what is known as the “fiduciary rule.” If implemented, it would require financial advisers to put clients’ best interests first when counseling them about retirement savings. In practice, it typically would prevent financial pros from steering you into a high-cost investment if similar low-cost choices are available.

The differences in fees — often fractions of a percent — may sound minuscule.

Over time, though, higher fees can dramatically reduce the amount of money that investors accumulate for retirement, according to the Securities and Exchange Commission and other investor watchdogs, and significantly increase the chances that savers will run out of money late in life.

In my latest for the Associated Press, how to save money for retirement without making the financial services industry even richer.

4 tax hacks you might not know

You know to contribute enough to your 401(k) to get the full company match. Maybe you’ve even adjusted your withholding so you’re not giving Uncle Sam an interest-free loan.

Yet you may feel the need to do even more, especially if you’re making the last big push toward retirement. These hacks allow you to shelter more money from taxes now and when you retire. In my latest for the Associated Press, the 4 crucial tax hacks you might not know.

Retire right — plan to do it twice

There’s the retirement that looks like the commercials: biking, travel, enjoying the family.

And then there’s the one where you can’t get up the stairs anymore.

Most of us happily plan for the first, when our health is good and energy high. The second can be hard to contemplate, when health falters and medical crises can change lives in an instant.

Yet a focus on just the active part of retirement can shortchange your quality of life once you begin to decline, which is why financial advisers suggest you also look at how you’ll live in that later phase. In my latest for the Associated Press, what you should consider for that second stage.

Q&A: Investing during retirement

Dear Liz: I’ll be retiring shortly. After 30 years of public service, I’m fortunate to have a generous pension. I’ll be paying off all my debts upon retirement, including my mortgage. I have a deferred compensation account that I will leave untouched until I’m required to take disbursements at 70 1/2 (15 years from now). Until then I will have disposable income but no significant tax deductions. Short of investing on my own in a brokerage account (and perhaps incurring capital gains taxes), are there any other investment vehicles that perhaps would be tax friendlier?

Answer: A variable annuity could provide tax deferral, but any gains you take out would be subject to income tax rates, which are typically higher than capital gains rates. (Annuities held within IRAs are subject to required minimum distributions starting after age 70 1/2. Those held outside of retirement funds will be annuitized, or paid out, starting at the date specified in the annuity contract.) Also, annuities often have high fees, so you’d need to shop carefully and understand how the surrender charges work.

Many advisors would recommend investing on your own instead and holding those investments at least a year to qualify for lower capital gains rates. This approach is particularly good for any funds you may want to leave your heirs, since assets in a brokerage account would get a “step up” in tax basis that could eliminate capital gains taxes for those heirs. Annuities don’t receive that step-up in basis.

You also shouldn’t assume that waiting to take required minimum distributions is the most tax-effective strategy. The typical advice is to put off tapping retirement funds as long as possible, but some retirees find their required minimum distributions push them into higher tax brackets. You may be better off taking distributions earlier — just enough to “fill out” your current tax bracket, rather than pushing you into a higher one.

Q&A: Fees can do serious damage to your retirement

Dear Liz: When I changed jobs, I rolled my 401(k) account into an IRA and took it to a financial planner. He invested it initially and now has a management company watching it. So now I am paying quarterly fees to him, the management company and the IRA custodian. The fees average about $2,000 a year. I am thinking about moving my account to my current 401(k), which has lower fees.

I feel like the planner has me in way too many investments, and my returns aren’t great. My account is up about $40,000 on a $122,000 initial investment. I will be 60 this year and plan on working for another six-plus years.

Answer: If your employer accepts IRA transfers — and many do — then rolling the money into your current 401(k) could be a great way to go.

Many 401(k) plans offer ultra-low-cost investment options that aren’t available to retail investors. Many also offer target date funds that would take care of diversifying your investments while making sure the mix gets more conservative as you get closer to retirement.

Right now you’re paying above-average fees to get below-average performance. If you had put your money into a low-cost option such as the Vanguard Balanced Index Fund five years ago, your account would now be worth nearly $190,000. The expense ratio for the balanced fund can be as low as 0.08%, compared with the 1.23% you’re paying now. (Your actual cost probably is higher; you didn’t include the expense ratios of the underlying investments in your account.)

Fees matter a lot. Higher fees depress returns and can increase your chance of running short of money in retirement.

At the same time, the years just before and after retirement are crucial because you’ll be making a lot of decisions with major consequences (such as when to claim Social Security and how much to withdraw from retirement accounts). Paying 1% in fees could make sense if you were getting comprehensive financial planning advice that addressed your retirement planning needs as well as other aspects of your finances, such as insurance, taxes and estate planning. If all you’re paying for is investment management, though, you can get that for a lot less.

If your employer doesn’t accept transfers or doesn’t have low-cost options, you could consider transferring your IRA to a custodian that offers low-cost computerized investment services. These include Betterment, Wealthfront, Vanguard Personal Advisor Services and Schwab Intelligent Portfolios, among others. The all-in fee for their services, including expense ratios of underlying investments, is typically less than 0.5%.

If you do opt for less expensive investment management, you still should consider hiring a fee-only financial planner before you retire to review your plan. You can find fee-only planners who charge by the hour at Garrett Planning Network.

Tuesday’s need-to-know money news

Today’s top story: Managing your 401(k) in uncertain times. Also in the news: How the Alternative Minimum Tax works, how owning or selling a home affects your taxes, and the 10 biggest tax havens on earth.

How To Manage Your 401(k) in Uncertain Times
Protecting your retirement.

How Does the Alternative Minimum Tax Work?
What you need to know about the extra tax bite.

How Owning or Selling a Home Affects Your Taxes
Both could save you money.

These are the 10 biggest tax havens on the planet
In case this year’s taxes have you thinking of relocating.