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Liz Weston

Q&A: Social Security and government pensions

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Dear Liz: When is the “sweet spot” for me to start receiving Social Security benefits? I am retired and collecting two government pensions — mine and my ex-husband’s. I paid into Social Security for 26 years of substantial earnings when I was in the private sector. I do not want to return to work to get to 30 years of substantial earnings in order to avoid the windfall elimination provision reduction. I will reach full retirement age early next year and have a family history of longevity (my parents lived into their 90s). I am paying all of my bills currently but will do more traveling once I am collecting Social Security. Should I wait until 70 to collect? I think I need to live until about 84 to make waiting a good choice. I tried to get this answer from a financial planner at a free seminar and he would not tell me without hiring him for further consultations.

Answer: That’s not surprising. Social Security claiming strategies can be a complex topic, and your situation is more complex than most.

As you know, the windfall elimination provision can reduce Social Security benefits for people receiving pensions from government jobs that didn’t pay into Social Security. The provision doesn’t apply to people who have 30 or more years of “substantial earnings” from jobs that did pay into Social Security. (The amount considered substantial varies by year, but in 2023 it’s $29,700.) Your 26 years of substantial earnings will mitigate, but not eliminate, the provision’s effects.

Social Security has tools that can help you estimate the impact. Start by opening an account with Social Security, if you haven’t already, and getting your earnings record from those 26 years. You’ll then enter each year’s worth of “substantial earnings” into Social Security’s windfall elimination provision calculator to determine what your benefit is likely to be at various ages.

Next, consider using a paid Social Security claiming site, such as Maximize My Social Security or Social Security Solutions, to get recommendations on when to claim rather than using calculators that purport to show a “break even age” for delaying Social Security.

These calculators typically don’t include important factors such as tax rates, rates of return and, for married couples, future survivor benefits. They also don’t really address “longevity risk” — the substantial danger that the longer you live, the more likely you are to run through your savings and wind up short of money.

On the other hand, you have not one but two government pensions that will provide guaranteed income for the rest of your life. If your Social Security benefit is truly “fun money,” rather than the lifeline it serves as for most people, maximizing your benefit may not be your top priority. But get all the information you can about the cost and benefits of claiming at different ages before making your decision.

Q&A: Should your retirement savings plan include life insurance? Here are some pros and cons

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Dear Liz: Are indexed universal life insurance products worthwhile, and how do they compare to a Roth IRA?

Answer: Both offer the potential for tax-free distributions in retirement, but indexed universal life insurance is a complex product with high expenses that’s not a good fit for most investors.

With a Roth IRA, virtually all of your money can go toward your retirement investment. (Most investments have fees of some kind, but you can minimize those by using exchange traded funds or low-cost index funds.) With permanent life insurance, some of your money goes toward paying premiums for the death benefit and other administrative expenses, including commissions for the person who sells you the policy. The remaining cash can be invested in accounts that are tied to the performance of a stock market index. Your principal is guaranteed, but the amount you earn is subject to caps.

Financial planners generally recommend that you first max out other retirement savings options, such as 401(k)s and IRAs, before considering investing through a life insurance policy. Also, you should be someone who needs permanent life insurance — the kind that is meant to cover you for the rest of your life. (Term insurance, by contrast, is a much less expensive option meant to cover you for a set term, such as 20 years.)

Some people do need permanent coverage. Their estates may be large enough to incur estate taxes that they want to pay with insurance, for example. Or they may have a special needs child who will require ongoing support. If you need permanent coverage, consider hiring a fee-only financial planner to help you sort through your options.

This week’s money news

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This week’s top story: Smart Money podcast on more money hot takes, and leaving your job. In other news: How businesses can navigate digital options, forgiveness, forbearance and other student loan changes to know, and what concierge medicine is.

Smart Money Podcast: More Money Hot Takes, and Leaving Your Job
This week’s episode starts with a round of Money Hot Takes.

The Tip Jar Is Dead. How Businesses Can Navigate Digital Options
Setting up tipping screens is a delicate balance. Here’s how businesses are making the most out of the new norm.

Forgiveness, Forbearance and Other Student Loan Changes to Know
Be proactive to get ahead of major federal student loan changes.

What Is Concierge Medicine? (And Should You Consider It?)
Less waiting, more access, longer visits — find out if concierge medicine is right for you.

Q&A: Social Security is insurance

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Dear Liz: My wife was 69 at the time of her passing. She was still working and not collecting Social Security. I am 72, retired and collecting Social Security. When I spoke with Social Security, I was told that I cannot collect on my wife’s Social Security. All I qualify for is a $255 death benefit. I asked what happened to her money that was collected all these years; I was told it goes into a general fund. Is there anything I can get from my wife’s Social Security?

Answer: If your current benefit is larger than the survivor benefit you would get based on her work record, then no.

Your question illustrates two common misconceptions about Social Security.

Social Security is not a 401(k) or other retirement fund that you pay into over time and then draw from in retirement. Social Security is actually insurance. (Social Security’s formal name is Old-Age, Survivors, and Disability Insurance, or OASDI.) It’s a pay-as-you-go system where the payroll taxes collected from current workers pay for the benefits received by people who are retired or disabled and their dependents.

The other misconception is that survivors are qualified for additional benefits on top of their own. In fact, survivors get the larger of the two benefits a couple was receiving — not both. This is, unfortunately, often a surprise to widows and widowers who see their incomes plunge after their partners die.

Q&A: Roth IRA or traditional IRA? Here’s why one might be a better choice for young workers

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Dear Liz: My mid-20s nephews and I discussed financial planning for them. After recommending they check with their employers for a 401(k) or equivalent program, we spoke about traditional versus Roth IRAs. Would younger investors benefit more from a Roth IRA because the length of time the money would be invested is so long that the eventual tax-free withdrawal of the earnings outweighs the initial tax benefits of a traditional IRA? At this time, we cannot determine if my nephews will have a higher tax rate post-retirement than now (even assuming income tax rates stay the same).

Answer: The usual advice has been that people should contribute to a Roth IRA rather than a traditional IRA if they expect to be in the same or higher tax brackets in retirement. (Contributions to Roths are not tax-deductible but withdrawals in retirement are tax-free. By contrast, contributions to traditional IRAs are often deductible, but withdrawals are taxed as income in retirement.)

Of course, you can’t predict future tax rates with any certainty. But it’s a pretty good bet that 20-somethings who are at the beginning of their careers will earn more — and thus face higher tax rates — down the road. In other words, your nephews’ current tax rates may be the lowest they’ll ever be. Your nephews may not get much benefit from a tax deduction now but could get huge benefits from tax-free withdrawals in the future.

Also, premature withdrawals from traditional IRAs are usually taxed and penalized, but you can always withdraw the amount you contribute to a Roth without paying taxes or penalties. That flexibility often appeals to young people who worry about “locking up” their money or who don’t yet have a substantial emergency fund.