Retirement

Q&A: Keeping retirement money in various accounts helps with tax bills

July 17, 2017 By Liz Weston

Dear Liz: I am having difficulty determining if I should invest money in my 457 deferred compensation account or in a taxable account, as I am in the 15% tax bracket.

Also, does it matter whether I invest in a Roth IRA instead of my traditional IRA? My biggest pot of money is in a taxable account, then my IRA, then a Roth. I am single, no dependents and over 50.

Answer: In retirement, having money in different tax “buckets” can help you better control your tax bill.

Taxable accounts, for example, can allow you to take advantage of low capital gains tax rates plus you can withdraw the money when you want: There are no penalties for withdrawals before age 59½ and no minimum distribution requirements.

Tax-deferred accounts allow you to save on taxes while you’re working but require you to pay income taxes on withdrawals — and those withdrawals typically must start after you turn 70½.

Roth IRAs, meanwhile, don’t have minimum distribution requirements, and any money you pull out is tax free, but contributions aren’t tax deductible.

Because most people drop to a lower tax bracket in retirement, it often makes sense to grab the tax benefit now by taking full advantage of retirement accounts that allow deductible contributions.

That means the 457 (generally offered by governmental and nonprofit entities) and possibly your regular IRA. (Your ability to deduct your IRA contribution depends on your income, since you’re covered by the 457 plan at work.)

If your IRA contribution isn’t deductible, then contribute instead to a Roth. If you still have money to contribute after that, use the taxable account.

If you expect to be in the same or higher tax bracket in retirement, though, consider funding the Roth first. Prioritizing a Roth contribution also can make sense if you have plenty of money in other retirement accounts and simply want a tax-free stash you can use when you want or pass along to heirs.

Q&A: Social Security lets you un-retire to avoid a benefit hit, but only once

July 10, 2017 By Liz Weston

Dear Liz: My wife recently retired at age 62 and will collect Social Security. But she has decided to return to work full time. I know she will collect less if she makes more than Social Security allows per month. If she eventually goes back to not working at all, can she go back to collecting the original amount?

Answer: Yes, but she’d be smart to reconsider her decision to start collecting Social Security early because she’s permanently reducing her benefit for little (if any) good reason.

The earnings test, which applies when people start Social Security early, takes away $1 of benefits for every $2 she earns over a certain limit, which is $16,920 in 2017. The earnings test will end when she reaches her full retirement age, which for people born in 1955 is 66 years and two months. Her check at that point would be what she originally received at 62, plus any cost of living increases.

But that original check is reduced by nearly 25% from what she would get at full retirement age, and the reduction lasts for the rest of her life. That’s a huge hit, and it should make her question the advisability of starting benefits early when so much could be taken away from her.

Fortunately, she has a little time to change her mind. Social Security allows applicants to withdraw their applications, allowing their benefit to continue growing, if they do so within 12 months of becoming entitled to benefits. People who withdraw their applications have to pay back any benefits that received in order to restart the clock.

This is a one-time do-over: Applications can be withdrawn only once in a lifetime and can’t be withdrawn after a year has passed. She can read more about this at the Social Security site, https://www.ssa.gov/planners/retire/withdrawal.html.

Social Security benefits make up half or more of most people’s retirement income. Making smart decisions is essential if you want to avoid a lifetime of regret.

At a minimum, people should use a free claiming-strategies calculator, such as the one on the AARP site, to determine when and how to begin benefits. For $40, they can use more sophisticated planners such as MaximizeMySocialSecurity.com and SocialSecuritySolutions.com.

Another good option is to consult a fee-only financial planner familiar with Social Security claiming strategies to make sure they’re not making an irrevocable mistake.

Q&A: Deferred compensation plans

June 26, 2017 By Liz Weston

Dear Liz: I’m 54 and plan on retiring at 55 with a government pension. I have about $450,000 in a 457(b) deferred compensation plan. I owe about $220,000 on my home. I would like to pay off my 15-year, 2.5% interest mortgage. This would free up $1,900 a month and leave us debt-free. Everyone I’ve spoken to says this is a bad idea since I’d lose my mortgage interest deduction and I’d be “investing” in a low-interest vehicle (my mortgage). My only other obligation is my daughter’s college education, and I’m paying that in cash. Am I crazy to pay off this mortgage?

Answer: You’re not crazy, but you probably haven’t thought this all the way through.

The money in your deferred compensation plan hasn’t been taxed. Withdrawing enough to pay off your mortgage in one lump sum would shove you into a higher tax bracket and require you to take out considerably more than $220,000 to pay the tax bill. You could easily end up paying a marginal federal tax rate of 33% plus any applicable state tax — all to pay off a 2.5% loan.

There are a few scenarios where using tax-deferred money to pay off a mortgage can make sense. Some people have so much saved in retirement plans that the required minimum distributions at age 70½ would push them into high tax brackets and cause more of their Social Security to be taxed. They also may have paid down their mortgage to the point where they’re no longer getting a tax break.

In those instances, it may be worth withdrawing some money earlier than required to ease the later tax bill. The math involved can be complex, though, and the decisions are irreversible, so anyone contemplating such a move should have it reviewed by a fee-only financial advisor who is familiar with these calculations.

In fact, it’s a good idea to get an objective second opinion from a fiduciary any time you’re considering tapping a retirement fund. (Fiduciaries are advisors who pledge to put your interests ahead of your own.)

During your meeting, you also should review the other aspects of your retirement plan. How will you pay for health insurance in the decade before you qualify for Medicare? If you’re a federal employee, you should be eligible for retiree health insurance but your premiums may rise once you quit work. If you’re planning to buy individual coverage through a healthcare exchange, what will you do if that’s yanked away or becomes unaffordable? How will you pay for long-term care if you need it, since that’s not covered by health insurance or Medicare?

You can get referrals to fee-only financial planners from the National Assn. of Personal Financial Advisors at napfa.org. You can find fee-only planners who charge by the hour at Garrett Planning Network, garrettplanningnetwork.com.

Q&A: Money in the bank isn’t safe from inflation

May 29, 2017 By Liz Weston

Dear Liz: I am 68 and not in very good health due to heart disease. I’m not sure what do with my savings of over $1 million, which sits in online bank accounts, earning 1.25% to 1.35% in 18-month certificates of deposit. (No account contains more than $250,000 to remain under the FDIC insurance limits.) The money will eventually go to my daughter, though I could use it for my retirement. I don’t have the appetite for market swings. What should I do with my money?

Answer: Your money currently is safe from just about everything except inflation. If you want to keep your nest egg away from market swings, you’ll have to accept that its buying power will shrink. There is no investment that can keep your principal safe while still offering inflation-beating growth.

If you do want a shot at some growth, you could keep most of your savings in cash but also invest a portion in stocks — preferably using low-cost index mutual funds or ultra-low-cost exchange-traded funds.

Before you know how to invest, though, you’ll need to think about your goals for this money. A fee-only financial planner could help you discuss the possibilities and come up with a plan. You can find fee-only planners who charge by the hour through the Garrett Planning Network, www.garrettplanningnetwork.com.

Q&A: Health savings accounts can supercharge retirement funds, but not for this guy

May 22, 2017 By Liz Weston

Dear Liz: Prior to retiring in 2015, I contributed to a health savings account. At the time my spouse and I were enrolled in my employer-provided high deductible health insurance plan. After I retired, I enrolled in an HMO plan my employer provided, which is not high deductible, and my wife enrolled in a Medicare supplemental plan. Can I make a one-time IRA rollover of $8,750 into the HSA? If not the $8,750, can I make any one-time contribution to the account while I am enrolled in the Kaiser health insurance plan? I have only $53 in the HSA. Are there any reasons to keep the account open or should I close it?

Answer: You did have the option, while you were enrolled in the high-deductible plan, to make a one-time rollover from your IRA to your HSA. The amount you could roll over is capped to the HSA contribution limit. The limit in 2015 would have been $7,650 ($6,650 for a family, plus a catch-up contribution of $1,000 for those 55 and over). You would have had to subtract from the rollover any amounts already contributed to the account that year.

Since you no longer have the high-deductible plan, though, rollovers and new contributions aren’t allowed. There’s no reason to keep open a plan with just $53 in it because most HSA providers charge monthly fees that will quickly eat up such a small balance. (Your employer may have paid these fees while you were working and covered by the high-deductible plan.)

That’s too bad, because a properly funded HSA can be an excellent way to save for medical expenses in retirement. HSAs offer a rare triple tax break: Contributions are pre-tax, the money can grow tax deferred and withdrawals are tax free when used for qualifying medical expenses. HSAs are meant to cover the considerable out-of-pocket expenses that come with high-deductible health insurance plans, but the money in the account can be rolled over from year to year and even invested so it can grow.

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

May 1, 2017 By Liz Weston

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.