Ask Liz Weston

Get smart with your money

Retirement

Even military careerists need a Plan B

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Dear Liz: I’m about to marry an active-duty military man. We’re in the process of marrying our finances, and I have several questions.

First, what is a good emergency fund for us? We run our household on his salary because I’m recently unemployed. I’ve always had a six-month emergency fund for myself, but because he’ll theoretically always be employed, should we have less savings in emergency funds and more in retirement and investments?

Second, along with my unemployment, I’m bringing about $15,000 in savings and $9,000 in student loan debt (at 4.5%). He has about $5,000 in savings and no debt at all. Neither of us has a retirement account or any other investments. I’m leaning toward paying off my debt so that we start on even ground, but I have a feeling that you’re going to tell me not to do that. What should I be considering at this time?

Answer: The military offers good benefits and generous pensions to people who make the armed services their career. But the pension probably won’t cover all your expenses in retirement. (Remember, if he retires after 20 years of service, he’ll get only 50% of his base pay.) Besides, there’s really no such thing as “guaranteed” employment, even in the armed services, so it’s smart to have a Plan B.

Your husband-to-be should be taking advantage of the federal Thrift Savings Plan, which works like a 401(k) for civilians, although there’s no employer match for service members. He can contribute up to $17,000 a year ($17,500 in 2013), his contributions are excluded from his taxable income, and the money grows tax-deferred until it’s withdrawn in retirement, at which point it’s taxed as regular income.

The Thrift Savings Plan also has a Roth option. Withdrawals from a Roth in retirement are tax-free, although contributions usually are included in taxable income. The exception: If your fiance is deployed, most or all of his income would be tax-free, so he would be able to make contributions to the Roth with tax-exempt income, said Joseph Montanaro, a certified financial planner with USAA. That’s a pretty great deal: no tax on the contributions going in, and no tax on the withdrawals coming out.

If your man isn’t deployed, he still might want to divide his contributions between the regular and Roth plans so that he would have different savings “buckets” to tap in retirement and thus more control over his tax bill.

He probably wouldn’t get a full military pension if he leaves or is forced out of the military before he has served 20 years. But he would be able to take his Thrift Savings Plan balance with him.

When you return to work, you also should start contributing to a retirement fund. If you don’t have access to a 401(k) or 403(b), you might contribute to an IRA or a Roth IRA.

Although you would be smart to pay off any high-rate debt, such as credit card balances, you need not be in a rush to pay off low-rate, tax-deductible debt such as student loans, especially if the rate you’re paying is fixed. Instead, focus on building up that emergency fund. The exact amount you need is more art than science, but a six-month fund would be prudent.

Don’t use your 401(k) to pay debt

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Dear Liz: I will be 61 in December. I have $15,000 in credit card debt at 9.9% and $41,000 in a certificate of deposit earning 3% per year. I have $590,000 in my 401(k) account. I want to pay off the credit card balance to redirect my income to paying off my $26,000 mortgage by the end of 2013. Which near-term option for paying off the credit card is better: close the CD and buy a new, lower-paying CD with the balance after paying the card off, or take a 401(k) distribution, leaving the $41,000 emergency fund untouched?

Answer: Since you’re older than 591/2, you would not have to pay penalties on any withdrawal from your 401(k). But a withdrawal would still be a bad idea for a number of reasons.

The most obvious is that you would have to pay taxes on any amount you take out. Typically 20% is withheld from any distribution, but your bill could well be higher depending on your federal and state tax brackets. In the 25% federal and 8% state brackets, you’d owe $3,750 in federal and $1,200 in state taxes on a $15,000 withdrawal. So even without penalties, you’d lose one-third of a withdrawal to taxes.

The money you take out also wouldn’t be able to earn any future tax-deferred returns for you. At 60, you have a life expectancy of a couple more decades. The money you plan to withdraw potentially could grow to more than $70,000, assuming 8% average annual returns, if you leave it alone.

So using 401(k) money to pay debt is almost as dumb for you as it would be for a younger person who would pay penalties and incur an even bigger potential loss of future tax-deferred money.

Use the CD money instead, and change your spending habits so you don’t incur any future credit card debt.

How Social Security calculates your check

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Dear Liz: I have been told over the years that your Social Security monthly benefit amount is computed using years closest to retirement. I have now been told benefits are calculated from your highest earning year in your working life. Which is true? I am 61 and unable to work more than part time for physical reasons, so now my income has gone down while I’m still contributing to Social Security from my earnings. Are my lower yearly earnings for the next couple of years going to lower my overall benefit when I do start drawing my benefit?

Answer: Your Social Security benefit is not based on either your earnings close to retirement or your highest-earning year. Your checks will be based on your 35 highest-earning years. That long period helps keep you from being too badly penalized if your earnings drop toward the end of your working career. You can find out more at http://www.ssa.gov/pubs/10070.html. You can estimate your future benefits with this calculator: http://www.ssa.gov/estimator.

Delaying Social Security increases your options

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Dear Liz: I’m confused by your answer about the “file and suspend” strategy for boosting Social Security benefits. You wrote that the higher-earning, younger spouse in this case had to wait until her full retirement age if she wanted to use this strategy to let her husband claim a spousal benefit while her own benefit continued to grow.

I was told by a financial planner and thought I had confirmed on the Social Security website that once I am 62 and my spouse is 66 (his full retirement age), I can file for and suspend my benefits, allowing him to claim my spousal benefit.

Answer: You’re confusing two different strategies. If your husband waits until his full retirement age to apply for benefits, he has the option of receiving a spousal benefit and allowing his own benefit to continue growing. But he can receive the spousal benefit only if you’ve applied to receive your own benefits.

If you’re younger than your full retirement age, you don’t have the option to “file and suspend” — in other words, to apply for your benefit and then suspend your claim so your husband can get benefits while yours continue to grow.

“The strategy of filing for retirement and suspending the retirement benefits to allow your spouse to collect is only available after full retirement age,” Social Security Administration spokesman Lowell Kepke said.

“File and suspend” can boost Social Security benefits

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Dear Liz: I am 63 and not nearly ready to collect Social Security. In fact I probably won’t be ready for quite a few years. My husband, who is 64, wants to collect on my Social Security as it is higher than his. Is there a way for him to do this that would not hurt me? I have called the Social Security office five times and have received five different answers. My husband went into the local office and they told him to have me apply for benefits and then after a short time send them a letter rescinding my application. That would allow him to collect on my work record and wouldn’t hurt my eventual benefit. I am not comfortable doing this. What do you suggest?

Answer: At your current age, you must start your own benefits for your husband to get a check based on your work record. The so-called spousal benefit is basically half your retirement benefit, and it will be somewhat reduced because your husband hasn’t achieved “full retirement age” (which is 66 for both of you). When he applies for spousal benefits, the Social Security Administration will compare that benefit with the one based on his own record and give him the larger of the two.

Starting benefits now, however, would lock you into a lower payment for the rest of your life. Your checks could be further reduced based on your earnings, if you continue to work.

If you can wait three years, you have another option called “file and suspend” that would allow your husband to collect a spousal benefit without reducing your eventual checks. Once you reach your full retirement age of 66, you can go to your local office to file for your benefit and then immediately suspend your application. That would allow your husband to collect a spousal benefit while your own uncollected benefit could continue to grow.

Another advantage for your hubby if you wait: He will have achieved his full retirement age when he starts receiving spousal benefits, so he would be allowed to switch to his own benefit later, if it’s larger. If he starts receiving spousal benefits before his full retirement age, he loses the option to switch.

You can learn more about the file-and-suspend strategy on the Social Security site at www.ssa.gov/retire2/yourspouse.htm. You may want to bring a printout of that page with you to the Social Security office. File and suspend is not an obscure strategy, but it doesn’t appear that your local office is quite aware of all the details.

Should you take a lump sum now or an annuity check later?

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Dear Liz: My former employer is offering the one-time opportunity to receive the value of my pension benefit as a lump-sum payment. The other option is to leave the money where it is and get a guaranteed monthly check from a single life annuity when I reach retirement age. I am 40 and single, and I have been investing regularly in a 401(k) since graduating from college. I have minimal debt aside from a car payment. When does it make financial sense to take a lump sum now instead of an annuity check later?

Answer: Theoretically, you often could do better taking a lump sum and investing it rather than waiting for a payoff in retirement. That assumes that you invest wisely, that the markets cooperate, that you don’t pay too much in investing expenses and that you don’t do anything foolish, like raid the funds early.

That’s assuming a lot. Another factor to consider is that the annuity is designed to continue until you die. It’s a kind of “longevity insurance” that can help you pay your bills if you live a long life.

Some financial advisors will encourage you to take the lump sum, since they may be paid more if you invest it with them. Consider consulting instead a fee-only financial planner who charges by the hour — in other words, someone who doesn’t have a dog in this particular fight. The planner can walk you through the math of comparing a lump sum to a later annuity and help you understand the consequences of both paths. This is a big enough decision that it’s worth paying a few hundred bucks to get some expert advice.