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Q&A: Social Security and break-even math

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Dear Liz: You recently wrote about the complexity of retiring with a government pension and Social Security. You left out one very important resource: the Social Security Administration. Going into a Social Security office and sitting with a representative who can explain exactly how much a person will get (almost impossible to determine online using formulas) was the most helpful thing I did. I retired with a government pension at 60 years of age, and at 63 I went to the SS office to chat. I learned that if I waited until full retirement age (67) my break-even point would be 18 years! I slept on the numbers, discussed that with a trusted advisor and filed to take my Social Security benefit. Couldn’t be happier. The employees in the local office were wonderful, knowledgeable about the windfall elimination provision and could give exact numbers.

Answer: It sounds like the representative you consulted encouraged you to make your decision using a simple break-even calculation. That’s unfortunate for a number of reasons.

Break-even calculations typically purport to show the point at which the larger checks you get from delaying your Social Security application outweigh the smaller checks you pass up in the meantime. But the calculators usually don’t include important factors, such as inflation, tax rates and the impact of your filing decision on survivor benefits. These calculators also don’t include pertinent information about life expectancies. According to Social Security actuarial tables, for example, 63-year-old females in the U.S. can expect to live an additional 21.24 years.

That’s average life expectancy, of course. The more educated you are and the more income you make, the more years you can probably add to that tally. And the longer you live, the more likely you are to run through your savings. Many people who are able to make ends meet in their 60s and 70s wind up struggling financially in their 80s because they started Social Security too soon, says actuary Steve Vernon, a former research scholar at the Stanford Center on Longevity.

Of course, you’ll be much less dependent on Social Security than most people, thanks to your pension. It’s possible your trusted advisor took that into consideration, along with your longevity profile, tax situation and other possible income sources, when suggesting you apply for a permanently reduced check. Most people can’t afford such reductions.

Q&A: Securities Investor Protection Corp. coverage

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Dear Liz: This is a follow-up question to your column concerning stock brokerage accounts and the coverage provided by Securities Investor Protection Corp. My husband and I are puzzled as to how the failure of a brokerage, which does not actually own our shares of stock, could cause us to lose that stock, leaving us to the limited protection the SIPC can provide. Can you explain what the sequence of events would be?

Answer: SIPC coverage kicks in when a brokerage fails and customer assets are missing. You’re correct that brokerages are required to keep customer assets separate from their own, so missing stocks and other investments would probably be due to fraud, which is rare. Most of the time when a brokerage fails, all customer assets are simply transferred to another firm.

SIPC protects up to $500,000, including a $250,000 limit for cash. Many brokerages also have private insurance in addition to SIPC coverage to protect against such losses.

Q&A: HELOC situation improves

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Dear Liz: Your recommendation that a retired couple consider a home equity line of credit to pay for home repairs astonished me. According to news reports, HELOCs are becoming harder and harder to find. Banks that still offer them have gotten stricter. And to suggest a reverse mortgage for a couple who only need $10,000, I think, is not the best option for them.

Answer: Lenders did tighten their requirements for HELOCs after the pandemic began, and some stopped offering them entirely. But the situation is starting to ease, thanks to rising levels of home equity and a generally strong economy.

The original letter writer’s spouse had proposed using a low-rate credit card to pay for a new furnace and water heater. Using a low-rate card isn’t a bad option if the balance can be paid off quickly, but could become expensive otherwise. Low rates are typically teaser rates that expire after a certain period. The couple then could try to roll the balance onto another low-rate card, but there’s no guarantee they would be approved for such a balance transfer or that they would get a large enough credit limit.

You’re quite right that a reverse mortgage wouldn’t be a great solution if the couple needed only $10,000, but the letter writer indicated they had little in savings. A reverse mortgage or line of credit could provide an ongoing source of funds for those with few other options.

Q&A: Adding sister to a house deed

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Dear Liz: A reader recently asked about giving a rental house to the sister that has been living in it for 10 years. You mentioned that the reader would have to file a gift tax return since there is a max of $15,000 for a gift exemption. Couldn’t the owner simply add the sister to the title so when they pass the sister becomes the sole owner of the house without having to deal with taxes, probate, etc? Similarly, if the sister dies first the current owner would retain ownership to give, sell, donate as they choose.

Answer: Adding the sister to the deed would be considered a gift, so the reader would still have to file a gift tax return.

Owning the home together would avoid probate and give the surviving sister a tax break, and that half of the house would get what’s known as a step-up in tax basis at the first sister’s death. Another option, if the reader wanted to retain ownership, would be a transfer-on-death deed, which is available in many states. The reader was clear that she wanted to give an outright gift, but she could consult a real estate or estate planning attorney about other options.

Q&A: Windfall elimination provision

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Dear Liz: I just read your answer regarding the windfall elimination provision question. I receive a pension after having retired from law enforcement. I was fortunate to be able to retire at 46. Then I landed a great job with excellent pay. I expect to pay into Social Security for a total of 17 years and I’ve been contributing the maximum for the last six. How will this affect my benefits? Will I still be penalized?

Answer: The only way the windfall elimination provision wouldn’t affect you is if you paid into Social Security for 30 years or more. If you pay Social Security taxes for 20 years or less, you’ll face the full impact of this provision, which affects those who get pensions from jobs that didn’t pay into Social Security. Starting at year 21, the effect begins to lessen until it disappears at year 30.

You can learn more about what to expect on Social Security’s site. Some of the paid Social Security claiming strategy sites, including Maximize My Social Security and Social Security Solutions, can incorporate the windfall elimination provision into their calculations if you want to model how different retirement dates might affect your benefits.

Q&A: Gift taxes vs. estate taxes

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Dear Liz: A reader recently asked about passing a $500,000 inheritance to their children. You mentioned the option of disclaiming, or refusing the inheritance so that it would go to their kids. You wrote, “If you decide not to disclaim and later give the entire $500,000 to your kids, you wouldn’t have to pay gift taxes until you gave away considerably more. Plus, gifts are tax free to the recipients.” Are you possibly mixing up gifting and inheriting? As I understand it, gifting to your kids is limited to something like $15,000 per parent per kid. Unless you have a huge family, that’s not going to add up to $500,000 of tax-free giving.

Answer: Many people get confused about how gift taxes work. The gift and estate tax systems are intertwined, causing further confusion.

There’s no limit on how much you can give away during your lifetime: You can give as much money as you want to as many people as you want. If you give more than $15,000 to any one recipient in a given year, however, you’re required to file a gift tax return. That doesn’t mean you owe gift taxes.

The amounts over $15,000 count against your lifetime estate and gift tax exemption, which is currently $11.7 million per person. So if you give someone $20,000, the extra $5,000 would be deducted from your $11.7-million lifetime exemption. Only after you exhausted that lifetime exemption would you owe gift taxes.