Q&A

Q&A: Don’t rush to collect Social Security

December 9, 2019 By Liz Weston

Dear Liz: I would like you to explain to us retirees why we should delay taking Social Security.

I have two tax preparers — and other people — who say delaying is a terrible idea. I’m in my 20th year of collecting Social Security, and I can assure you that people who delay are making a dreadful mistake. Please check this out!

Answer: Your tax preparers may have had a point 20 years ago, but a lot has changed since then, including life expectancies and prevailing interest rates. It’s unfortunate if your advisors haven’t kept up with copious research showing that delaying Social Security makes sense for most recipients.

One issue of particular interest to tax pros is the “tax torpedo.” That’s a sharp rise and then fall in the marginal tax rate caused by taxation of Social Security benefits. Researchers found the tax torpedo could nearly double the marginal tax rate for many middle-income families. People in the 22% federal tax bracket, for example, could see their marginal tax rate jump to 40% on a portion of their income.

Two decades ago, this would have been an issue for fewer taxpayers because most did not owe income tax on their Social Security benefits. Now more than half pay taxes on their benefits because Congress hasn’t updated certain income limits to reflect inflation.

The researchers found that delaying the start of benefits until age 70 and tapping retirement funds instead could reduce the tax torpedo’s effect. This approach not only maximizes Social Security benefits but also reduces the minimum amounts that must be distributed starting at age 70½. For more details, you can point your tax advisors to the July 2018 issue of the Journal of Financial Planning.

The National Bureau of Economic Research also has numerous papers on Social Security-claiming strategies, including “Recent Changes in the Gains from Delaying Social Security,” “Leaving Big Money on the Table: Arbitrage Opportunities in Delaying Social Security,” “The Power of Working Longer” and “The Decision to Delay Social Security Benefits: Theory and Evidence.”

Q&A: Too many credit cards? Protect your credit scores while closing accounts

December 9, 2019 By Liz Weston

Dear Liz: Over the years, my husband and I have accumulated a number of credit cards. All have had a zero balance for years. I want to start canceling these cards, but I’m concerned that will hurt our great credit scores. How should I go about this, or should I?

Answer: As you probably know, closing credit accounts won’t help your scores and may hurt them. That doesn’t mean you can never close a credit card, but you shouldn’t close a bunch of them at once or close any if you’ll be in the market for a major loan, such as a mortgage or auto loan.

If you’re not planning to borrow money in the near future, then you can start closing accounts one at a time. You’ll probably want to keep the cards with the highest credit limits, and perhaps your oldest card as well. Monitor your scores to see how long they take to recover from each closure. You may need to wait a few months before shutting the next account.

Be sure to use your remaining cards occasionally by charging small amounts and paying the balance in full. That will keep the cards active and help prevent the issuer from canceling them.

Q&A: Direct tuition payment pros, cons

December 2, 2019 By Liz Weston

Dear Liz: You recently answered a question from someone whose parents misused trust funds intended for their child’s education. I chose to pay the colleges directly each semester once my grandchildren enrolled rather than give money to the parents. I decided that was the only way I could be assured the money went for what grandma intended.

Answer: Your grandchildren are fortunate to have a generous grandmother, but your strategy has some drawbacks as well as advantages.

Direct tuition payments aren’t considered gifts to the child, which means no gift tax return is required. Your payments could, however, reduce any need-based financial aid the children could get. Also, your approach requires that you be ready and able to make the tuition payments when the children reached college age. Your death or a financial setback could have turned your good intentions into an empty promise.

Q&A: Don’t fall for these common Social Security misconceptions

December 2, 2019 By Liz Weston

Dear Liz: I decided to start taking Social Security benefits this summer when I turned 62. My monthly benefit is $1,809. My wife turned 62 at the end of last year and started her benefit of $841 a month. I just accepted an unexpected job offer that will pay me more than $130,000 a year. I suspect I should consider suspending my benefit at this point and work as many years with this company as possible. If I choose to suspend my benefits now and allow my benefits to remain suspended until my full retirement age of 66 years six months, I will pass up benefits of $112,000 over the next 4.5 years. Granted that amount will be overshadowed by the additional new income and the opportunity to contribute to a 401(k), but is it out of the question to continue my current benefit and just pay the 85% tax on the Social Security we receive each year in addition to our other income?

Answer: Social Security is complicated, so it’s not surprising that so many people get the details wrong. Unfortunately, those details can have a huge effect on financial well-being in retirement. The difference between the best claiming decisions and the worst can total more than $250,000, researchers have found.

Let’s start with the detail you need most: You don’t have the option right now of suspending your benefit. Only people who have reached their full retirement age can suspend. You can, however, withdraw an application within the first 12 months. You will have to pay back all the money you’ve received from Social Security, but then it will be as if you’d never applied. Your benefit can continue to grow by 5% to 8% each year until you restart your benefits or turn 70, whichever comes first.

Withdrawing your application is a good idea because otherwise your new job will offset all of your Social Security benefit.

Because you started Social Security early, you are subject to the earnings test and your benefit will be reduced by $1 for every $2 you earn over a certain limit, which in 2020 is $18,240. Your six-figure income would reduce your benefit to zero.

This earnings test disappears at full retirement age, and any money that was withheld because of it is added back into your benefit over time. In the meantime, however, you’ve given up the more valuable 5% to 8% growth in your benefit and reduced your survivor benefit as well.

Social Security taxation also works differently than what you’ve described. You never have to pay taxes equal to 85% of your benefit. If your income exceeds certain levels, then up to 85% of your benefit could be subject to taxation. (To illustrate, that means if you’re in the 10% federal tax bracket, you’d pay 10% on up to 85% of your benefit. It’s more complicated than that, but that may help you understand the difference between losing a huge chunk of your benefit and having to pay tax on a portion of it.)

Given all these complexities, it’s important for people to use a few Social Security claiming calculators before applying. Ideally, they also would consult a financial planner who’s been educated on Social Security claiming strategies.