Ask Liz Weston

Get smart with your money

Retirement

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.

How much do you really need to retire?

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Dear Liz: None of the Web-based tools I’ve seen really get at the heart of the problem of how much I really need in retirement. For example, if I am diligent and save 20% of my income (I earn over $150,000), why would I need to replace 95% or even 80% of my income to maintain my standard of living in retirement? If I subtract the 20% going to savings, another 10% for the costs of working (clothes, lunches, gas) and reduce my income tax 5%, shouldn’t I be living the same lifestyle at 65% of my current income? Now, if I have a pension that will replace 10% of my pay, and if Social Security benefits for my spouse and me replace 30%, don’t my investments have to produce only the remaining 25%? Or am I missing something?

Answer: The further you are from retirement, the harder it can be to predict how much you’ll need when you get there.

Financial planners often use an income replacement rate of 70% to 80% as a starting point. It’s just that, though. Planners will tell you some of their clients’ spending actually increases in the early years of retirement as they travel and indulge in other expensive hobbies. Those who are frugal or used to living well below their means are often able to retire comfortably with a much lower income replacement rate.

A big wild card is the cost of medical and nursing care in your later years. The U.S. Bureau of Labor Statistics’ Consumer Expenditure Survey shows average overall spending tends to drop after retirement and continues to decline as people age. Serious illness or a nursing home bill can cause spending to surge late in life, however, leading to a U-shaped spending pattern for many.

Taxes also are hard to predict. While most people drop into a lower tax bracket once they stop working, those with substantial retirement incomes and investments may not. Tax rates themselves could rise in the future, even if your income doesn’t.

Social Security benefits may change, as well. Although it’s highly unlikely the program will disappear, some proposals for changing Social Security reduce checks for higher earners.

Once you’re within a decade or so of retirement, you should have a better handle on what you’ll spend once you quit work. Before that point, err on the side of caution. Assuming a higher income replacement rate gives you wiggle room once you’ve retired — or the option to retire earlier if it turns out you need less.

Inherited IRA may have more options than you’re told

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Dear Liz: My partner passed away a little more than a year ago. I inherited his 401(k) and life insurance. I opened an IRA in which to place the amount of the 401(k), but the company told me that after a year (which is now), I have to withdraw the money over five years. Is that really required? I’d like to be able to have it on hand in case of an emergency but at the same time save it for our 2-year-old son’s college education.

Answer: Since you weren’t married, you don’t have the option of treating this inherited account as your own. That would have allowed you to delay withdrawals until after you turned 70 1/2 , if you wanted.

The fact that this is a non-spouse inherited IRA, however, doesn’t necessarily mean you’re bound by the five-year rule. That rule requires the IRA be distributed by Dec. 31 of the fifth year following the year of the original retirement account owner’s death. You may also have the option of beginning distributions based on your life expectancy. That would allow the bulk of the money to remain in the IRA, continuing to earn tax-deferred returns, and is usually a better choice.

Whether you have this second option depends on the terms of the IRA and the original 401(k) plan.

“It is important to check the IRA terms rather than rely on oral statements since the five-year option may be pushed when it is not required,” said Mark Luscombe, principal analyst for CCH Tax & Accounting North America. “It is also important to make a determination on the availability on the life-expectancy rule in the year after death since distributions must start under the life-expectancy rule in that year. Waiting too long could force one into the five-year rule by default.”

How divorced people can get spousal benefits

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Dear Liz: I’ve been reading with interest your answers to questions about Social Security spousal benefits, particularly those available to divorced spouses. What if the former spouse is now remarried for more than 10 years, and the current spouse is receiving benefits? Are spousal benefits still available and how are they calculated?

Answer: The answer depends on whose earnings record we’re talking about, so a few pronouns might have helped clarify your question.

Let’s say you’re the earner. If your former spouse has remarried, then he is no longer eligible to receive spousal benefits based on your earnings record. Only divorced people whose marriages lasted 10 years and who are not married can get spousal benefits based on an ex’s earnings record.

If you’re the one hoping for spousal benefits, however, it doesn’t matter that your ex has remarried as long as you’re unmarried. Your ex’s current spouse and any previous spouses who qualify can receive spousal benefits. The amounts they get don’t affect any other spouse’s checks or the checks received by the earner (your ex).

Spousal benefits can be up to half the earner’s “primary insurance amount,” which is the check the earner would get if she started Social Security at full retirement age. The benefits are permanently discounted if the spouse or ex-spouse begins receiving them before his own full retirement age.

Is a Roth worth losing a tax deduction?

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Dear Liz: Everyone talks about Roth IRAs and how beneficial they are. But I am self-employed, my husband contributes 16% toward his 401(k), our house is paid off, and we no longer have dependents to deduct on our 1040 tax return. My contribution to my traditional IRA is the only tax deduction we have left. Should I consider a Roth anyway? If so, why?

Answer: A Roth would give you a tax-free bucket of money to spend in retirement. That would give you more flexibility to manage your tax bill than if all your money were in 401(k)s and traditional IRAs, where your withdrawals typically are taxable. Also, there are no minimum distribution requirements for a Roth. If you don’t need the money, you can pass it on to your heirs. Other retirement funds require you to start taking money out after you turn 701/2. If you need to crack into your nest egg early, on the other hand, you’ll face no penalties or taxes when you withdraw amounts equal to your original contributions.

So is it worth giving up your IRA tax deduction now to get those benefits? If you have a ton of money saved, you want to leave a legacy for your kids and you’re likely to be in the same or a higher tax bracket in retirement, the answer may be yes. If you’re like most people, though, your tax bracket will drop once you retire. That means you’d be giving up a valuable tax break now for a tax benefit that may be worth less in the future.

You may not have to make a choice, however, between tax breaks now and tax breaks later if you have more than $5,500 (the current annual IRA limit) to contribute. Since you’re self-employed, you may be able to put up to $51,000 in a tax-deductible Simplified Employee Pension or SEP-IRA. At the same time, you could contribute up to $5,500 to a Roth (assuming your income as a married couple is within or below the phase-out range for 2013 of $178,000 to $188,000).

This would be a great issue to discuss with a tax pro.