Ask Liz Weston

Get smart with your money

Retirement

Maximizing Social Security benefits requires some patience

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Dear Liz: I am 65 and recently visited our local Social Security office to apply for spousal benefits. (My wife, who is also 65, applied for her own benefit last year.) I wanted to get the spousal benefit, even if the amount is discounted, so I can let my own Social Security benefit grow. The Social Security office manager advised us that I cannot claim spousal benefits until my full retirement age. You said in a recent column that I can. Who is correct?

Answer: You can apply for spousal benefits before your own full retirement age. But doing so means you’re giving up the option of switching later to your own benefit. The office manager gave you correct information, based on your goal. If you want the choice of letting your own benefit grow, you must wait until your full retirement age (66) to apply for spousal benefits.

Divorced retiree entitled to spousal Social Security benefits

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Dear Liz: My daughter, 63, has been recently amicably divorced and receives a small alimony ($1,000). Her ex-husband of 30 years is a doctor who just retired. Is she entitled to part of his Social Security? Neither has remarried.

Answer: Because they were married for more than 10 years, your daughter should qualify for spousal benefits, which can equal up to half of her ex’s benefit at his full retirement age. That amount would be permanently discounted if she applies before her own full retirement age (which is 66).

The ex’s marital status doesn’t matter, although your daughter’s does. If she remarries, she will lose access to spousal benefits as a divorced spouse. This is just one of the ways that spousal benefits differ from survivor’s benefits, which are based on 100% of the earner’s benefit and which widows and widowers can receive even if they remarry after age 60.

Don’t rush to pay taxes

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Dear Liz: I am a CPA and fairly knowledgeable about investing, but I have a question about my IRAs. I am 58 and my husband is in his mid-80s. We both are retired with federal pensions and no debt other than a mortgage. My plan is to start taking money annually from my traditional IRA in two or three years. I want to reduce the required minimum distribution I will need to start taking at age 701/2 and lessen the tax impact at that time. Should I put these annual withdrawals in my regular investment account or should I put them in the Roth IRA? My goal is to lessen the tax impact on my only child when he ultimately inherits this money. Does my plan make sense?

Answer: Your letter is proof that our tax code is too complex if it can stymie even a CPA. Still, it’s hard to imagine any scenario where you’d be better off accelerating withdrawals from an IRA and putting them in a taxable account.

A required minimum distribution “is merely a requirement to take the money out anyway,” said Certified Financial Planner Michael Kitces, an expert in taxation. “All you’re doing by taking money out early to ‘avoid’ an RMD [required minimum distribution] is voluntarily inflicting an even more severe and earlier RMD on yourself.”

In other words, you’d be giving up future tax-advantaged growth of your money for no good reason.

What might make sense, in some circumstances, is moving the money to a Roth. You can’t make contributions to a Roth if you’re not working, because Roths require contributions be made from “earned income.” What you can do is convert your traditional IRA to a Roth, either all at once or over time. You have to pay taxes on amounts you convert, but then the money can grow tax-free inside the Roth and doesn’t have to be withdrawn again during your lifetime, since Roths don’t have required minimum distributions. Whether you should convert depends on a number of factors, including your current and future tax rates and those of your child.

“In other words, if your tax rate is 25% and your child’s is 15%, just let them inherit the [traditional IRA] account and pay the lower tax burden,” said Kitces, who has blogged about the Roth vs. traditional IRA decision at http://www.kitces.com. “In reverse, though, if the parents’ tax rate is lower … then yes, it’s absolutely better to convert at the parents’ rates than the child’s. In either scenario, the fundamental goal remains the same — get the money out when the tax rate is lowest.”

If you do decide to convert, remember that the conversion itself could put you in a higher tax bracket.

“It will be important not to convert so much that it drives up the tax rate to the point where it defeats the value in the first place,” Kitces said. “Which means the optimal strategy, if it’s to convert anything at all, will be to do partial Roth conversions to fill lower tax brackets but avoid being pushed into the upper ones.”

Survivor benefits: what you can expect

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Dear Liz: Two years ago, I elected to start my Social Security benefits early, at age 62. My current benefit is $1,350 per month. My spouse, currently working, will be turning 62 next year and is also planning to take an early retirement benefit because of health issues. Her benefit is expected to be slightly more than my benefit at that time. If she dies before me, what can I expect to collect from Social Security as the spouse of someone who started benefits early?

Answer: If your wife dies before she begins receiving Social Security, your survivor’s benefit would be based on what’s known as her “primary insurance amount.” That’s the amount she would receive at full retirement age (which is 66 for those born between 1943 and 1954; after that, full retirement age increases gradually to age 67 for those born in 1960 or later).

Once she begins benefits, though, your survivor’s benefit is based on what she’s actually getting. So if she receives a reduced benefit, your survivor’s benefit is reduced as well. It would be further reduced if you, as a widower, begin taking survivor’s benefits before your own full retirement age.

You would not be able to get your own benefit plus a survivor’s benefit if your wife should die, by the way. You would get the larger of the two, but not both.

Are Roths safer than other IRAs?

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Dear Liz: I found your recent discussion of Roth IRAs informative. But I’ve been told that one of the main advantages of a Roth vs. a traditional IRA is that a Roth is a safer investment when it comes to creditors trying to attack it. How can that be? Is one type of IRA safer than another?

Answer: The short answer is no.

Employer-sponsored retirement plans, including 401(k)s and 403(b)s, typically have unlimited protection from creditors in Bankruptcy Court. The exceptions: The IRS and former spouses can make claims on such plans.

Individual retirement accounts, including IRAs and Roth IRAs, lack the protection afforded by the Employee Retirement Income Security Act, or ERISA. But the bankruptcy reform law that went into effect in 2005 protects IRAs of all kinds up to a certain limit (which in April rose to $1,245,475).

Short of bankruptcy, the amount of your IRAs or Roth IRAs that creditors can access depends on state law.

If there’s any chance you’ll be filing for bankruptcy or the target of a creditor lawsuit, you should talk to an experienced bankruptcy attorney about your options.