Ask Liz Weston

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Q&A

Q&A: The idea here is not to cheat public servants

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Dear Liz: Thanks for your column about Social Security claiming strategies. Here’s a further complication you didn’t address. If the surviving spouse is a teacher in many states, access to survivor’s Social Security benefits is further restricted (if not entirely blocked) by a misogynistic, anti-teacher ruling dubbed the windfall elimination provision, which perhaps was a backlash against the women’s liberation movement of the 1970s and 1980s.

Any clarification on the windfall elimination provision’s inconsistent application and its impact on my widow’s fixed income will be greatly appreciated.

Answer: The explanation is actually a lot more prosaic.

The windfall elimination provision and a related measure, the government pension offset, were not designed to rob public servants of benefits other people get. Instead, the provisions were meant to keep those who get government pensions from getting significantly bigger benefits than people in the private sector.

The provision that would reduce and possibly eliminate your spouse’s survivor benefit is actually the government pension offset. The offset, like the windfall elimination provision, applies to people who get pensions from jobs that didn’t pay into the Social Security system. (Some school systems, as well as other state and local government employers, have opted out of Social Security and provide their own pensions instead.)

If both you and your spouse had only Social Security and no government pensions, one of your two Social Security checks would stop at your death. After that, your spouse would get one check — the larger of the two checks the household received — as a survivor benefit.

If the government pension offset didn’t exist, your widow c​ould receive two checks: a survivor benefit equal to your Social Security benefit, plus her pension. She potentially would be getting a lot more from Social Security than those who paid into Social Security their entire working lives.

The windfall elimination provision, meanwhile, applies to people who have government pensions but also worked in jobs that paid into Social Security.

When people don’t pay into the system for several years because they have jobs with government pensions instead, their annual Social Security earnings for those years are reported as zero. Because Social Security is based on ​workers’ 35 highest-earning years, those zeros make it look like they have lower lifetime earnings than they actually did.

That’s a problem because the Social Security system is progressive, replacing more income for lower-earning workers than for higher-earning ones. Without adjustments, people with pensions would look like lower earners than they actually were. They would wind up with bigger Social Security checks than someone who had the same income in a private-sector job that paid in a lot more in Social Security taxes.

These provisions are complicated and hard to explain, which is part of the reason some people jump to the conclusion they’re being denied something others are getting. In reality, the provisions were meant to make the system more fair.

Q&A: Don’t run out of money in retirement: Here’s how much to use per year, and why

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Dear Liz: I am confused about “safe withdrawal rates” from retirement accounts. I’ve read that withdrawing 4% of savings each year is the gold standard that financial planners utilize to ensure that life savings are preserved in retirement.

However, if the Standard & Poor’s 500 index returns on average 8% a year, and if the life savings are locked down in a mutual fund that is indexed to the S&P 500, then shouldn’t the annual withdrawal amount, to preserve those savings, be 8%? Limiting my withdrawals to 4% means my retirement would be pushed several years down the road. Can you clarify?

Answer: It’s good you asked this question before you retired, rather than afterward when it might have been too late.

You’re right that on average, the S&P 500 has returned at least 8% annualized returns in every rolling 30-year period since 1926. (“Rolling” means each 30-year period starting in 1926, then 1927, then 1928, and so on.)

But the market doesn’t return 8% each and every year. Some years are up a lot more. And some are down — way down. In 2008, for example, the S&P 500 lost about 37% of its value in a single year.

Such big downturns are especially risky for retirees, because retirees are drawing money from a shrinking pool of assets. The money they withdraw doesn’t have the chance to benefit from the inevitable rebound when stock prices recover. Bad markets, particularly at the beginning of someone’s retirement, can dramatically increase the odds of running out of money.

Inflation also can vary, as can returns on cash and bonds. All these factors play a role in how long a pot of money can be expected to last. The “4% rule” resulted from research by financial planner William Bengen, who in the 1990s examined historical returns from 1926 to 1976. Bengen found there was no period when an initial 4% withdrawal, adjusted each year afterward for inflation, would have exhausted a diversified investment portfolio of stocks and bonds in less than 33 years.

Some subsequent research has suggested a 3% initial withdrawal rate might be better, especially for early retirees or those with more conservative, bond-heavy portfolios.

Free online calculators can give you some idea of whether you’re on track to retire. A good one to check out is T. Rowe Price’s retirement income calculator. But you’d be smart to run your findings past a fee-only financial planner as well. The decisions you make in the years around retirement are often irreversible, and what you don’t know can hurt you.

Q&A: Deciding when to claim Social Security benefits

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Dear Liz: In a recent article you discussed delaying Social Security benefits and wrote that for married couples, only the higher earner needs to wait until age 70 to get the largest possible check. I don’t understand the logic behind that statement.

I have always been told to wait until 70 to collect; however, my husband is the higher wage earner. Wouldn’t I still benefit from waiting until 70? If he is a few years younger than me, does that make a difference? If I don’t have to wait until 70, I am all for collecting at 66.

Answer: As you know, each year you delay boosts the check you get by roughly 7% to 8%. That’s a guaranteed return you can’t match elsewhere and why many financial planners encourage clients to delay claiming if they can. The “break-even” point — where the benefits you pass up are exceeded by the larger checks — can vary depending on the assumptions you make about investment returns, inflation and taxes. Generally speaking, you’ll be better off delaying until at least 66 if you live into your late 70s. If you delay until age 70, when your benefit maxes out, you’ll pass the break-even point in your early 80s.

None of us has a crystal ball, of course, and planners make the argument that Social Security should be viewed as longevity insurance: The longer you live, the more likely you are to spend your other assets and depend on your Social Security for most or all of your income. Given that reality, it makes sense to maximize that check.

That’s true for all individuals claiming Social Security, but married couples have another complication. When one dies, the other will have to get by on a single check — the larger of the two checks the couple was receiving. That’s the check that should be maximized, so it’s more important that the higher earner delay than that both spouses delay.

If you want a more detailed discussion of the issue, read financial planner Michael Kitces’ blog post “Why it rarely pays for both spouses to delay Social Security benefits” at kitces.com.

Q&A: What’s better, collecting Social Security early or blowing through retirement savings?

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Dear Liz: I am married and six months away from my full retirement age, which is 66. I have not filed yet. My wife started collecting Social Security at 62 but does not get very much. We are both in excellent health and have longevity in the genes. We don’t own a home. I have around $960,000 in diversified investments. I take out around $7,000 to $8,000 a month to meet my monthly expenses. Fortunately, the markets have been good, helping my portfolio, but I am not counting on that to continue at the same pace.

Doesn’t it make more sense to be taking less money out each month by starting Social Security now? I know I would receive less money than waiting until 66 or later, but between my check and the spousal benefit my wife could get, I would reduce my annual living expense withdrawals from my account by close to 50%. This would give my portfolio more opportunity to grow, since I will not be taking out so much every month.

I wish I could cut my expenses or could earn more income but cannot at this point. I am shooting for not taking more than 5% a year out of the portfolio going forward.

Answer: You’re right that something needs to change, because your withdrawal rate is way too high.

You’re currently consuming between 8.75% and 10% of your portfolio annually. Financial planners traditionally considered 4% to be a sustainable withdrawal rate. Any higher and you run significant risks of running out of money.

Some financial planning researchers now think the optimum withdrawal rate should be closer to 3%, especially for people like you with longevity in their genes. Chances are good that one or both of you will make it into your 90s, which means your portfolio may need to last three decades or more.

So even if you start Social Security now, you’ll need to reduce your expenses or earn more money to get your withdrawals down to a sustainable level.

Generally, it’s a good idea for the higher earner in a couple to put off filing as long as possible. The surviving spouse will have to get by on one Social Security check, instead of two, and it will be the larger of the two checks the couple received. Maximizing that check is important as longevity insurance, since the longer people live, the more likely they are to run through their other assets. Your check will grow 8% each year you can delay past 66, and that’s a guaranteed return you can’t match anywhere else. In many cases, financial planners will suggest tapping retirement funds if necessary to delay filing.

But every situation is unique. Your smartest move would be to consult a fee-only financial planner who can review your individual situation and give you personalized advice.

Q&A: The ins and outs of inherited IRAs

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Dear Liz: I have questions about inherited IRAs. A friend has designated me and three others as beneficiaries of her IRA. Is this to be considered community property with my husband? How can I inherit this as “sole and separate property”? Must taxes be paid on this? Also, may I give gifts of cash to relatives beforehand rather than naming them as recipients of my IRA and burdening them with taxes? If I do not name survivors to my IRA, what happens to my hard-earned money after I die?

Answer: Inheritances are considered separate property in every state, including community property states. If you commingle the funds — by depositing a withdrawal in a jointly held checking account, for example — then that money potentially becomes community property. You should consult a tax pro or financial planner about the rules governing non-spouse inheritors, since they’re somewhat complicated. You’ll pay income taxes on withdrawals from regular IRAs you inherit, but typically not from Roths.

You’re welcome to give anyone as much as you want, and they won’t have to pay taxes on the gift. You could owe taxes if you give away enough money, but that’s unlikely. You have to file a gift tax return if you give more than $15,000 per recipient in a given year, but you won’t actually pay gift taxes until the amounts you give away over that annual exclusion limit exceed your lifetime limit, which is currently $11.2 million.

If you’re concerned about taxes, though, naming people as IRA beneficiaries is often a smarter tax move than not doing so and having your estate inherit the money.

If your estate is the beneficiary, the money typically would have to be paid out to your estate’s heirs — and taxed — faster than if specific people were named. Your heirs might have to empty the account within five years, or the IRA custodian may opt to distribute the whole amount to the estate in one taxable distribution. Naming people, on the other hand, may allow the option of stretching the IRA, which means taking distributions over their lifetimes. The tax-deferred money that remains in the account can continue to grow. This is another topic to discuss with your advisor.

Q&A: Their kids are spendthrifts. How do parents protect them with a trust?

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Dear Liz: My wife (71) and I (68) have been diligent savers our entire lives. We have accumulated IRA assets of approximately $2 million along with a house and other assets. Our total estate is under $10 million. We have two adult children in their 20s who did not inherit the saving gene. My question is: Does a trust exist that would maintain the IRA’s tax-deferred status, make required minimum distributions to our kids and include appropriate spendthrift provisions? Also, would the distributions be based on our life expectancies or on theirs?

Answer: Yes, you can create a spendthrift trust and name it as the beneficiary of your IRAs. Your children could be named beneficiaries of the trust. Required minimum distributions for inherited IRAs would be based on the elder child’s life expectancy. Your children would not be able to “invade” or tap the principal.

A spendthrift trust would not only prevent your kids from blowing through any money left in the IRAs. It also would prevent creditors from getting the money in case of bankruptcy. In many states, inherited IRAs are vulnerable to creditor claims.

Here’s the thing, though: This is a question you should be asking your estate planning attorney. If you don’t have one, you need to get one. People with small, simple estates may be able to get away with do-it-yourself planning, but yours is neither small nor simple. Trying to save money by using software or forms just isn’t a good idea. Whatever money you save may be wasted when your estate plan goes awry in ways you didn’t foresee, because you’re not an estate planning expert.

Trusts that name IRAs as beneficiaries, for example, must have special language to accomplish what you want, said Jennifer Sawday, an estate planning attorney in Long Beach. Without the right language, the IRA custodian might liquidate the IRA instead. That would trigger the taxes and lump sum payouts you’re trying to avoid.