Ask Liz Weston

Get smart with your money

Retirement

How the “earnings test” works

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Dear Liz: Hi. I learned the hard way about taking early Social Security benefits. I kept working and wound up losing $1 of Social Security benefits for every $2 I earned over a certain low threshold. Do I get this money back at some point or is it a penalty?

 Answer: It’s considered a penalty, but you also get the money back. This so-called “earnings test” is one of several ways the Social Security system tries to discourage people from taking benefits early. The threshold for exempt earnings in 2012 is $14,640. After that point, your Social Security checks will be reduced $1 for every $2 you earn until you reach full retirement age. Once you reach that age, your checks will be increased to reflect the withheld amounts.

Parents’ estate plan triggers IRA tax bill

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Dear Liz: My sister and I are in the middle of distributing our parents’ estate. The beneficiary of the estate is a trust. Part of the estate consists of a traditional IRA, which will be split between my sister and me. The problem is that because the IRA will be distributed from the trust and is considered a non-spouse distribution, I’m told that we’ll have to pay taxes on the entire distribution. It’s a good chunk of change. I’m almost 60. Is there any way that I can roll the IRA into my own and take minimum distributions? I’d rather not pay the tax all upfront.

Answer: That’s understandable, since it’s typically much better to stretch distributions out as long as possible so that the money can continue to grow (and you can replace one big tax bill with smaller ones as you take distributions).

Unfortunately, the way your parents structured their estate ties your hands, although perhaps not to the extent you’ve been told.

It appears from your question that the IRA either failed to name a beneficiary or named the estate as the beneficiary, said Mark Luscombe, principal federal tax analyst for tax research firm CCH.

“Assuming that is the case, since estates do not have life expectancies, the IRA cannot be distributed over a beneficiary life expectancy as it could have been had an individual been named the IRA beneficiary,” Luscombe said. “Instead, it must be distributed under the terms of the IRA document over a period that cannot exceed five years.”

The exception is if the IRA owner before dying had already reached the age of 701/2 and begun distributions, Luscombe said. In that case, distributions can continue to the estate over the IRA owner’s life expectancy. If the IRA owner was quite elderly when he or she died, this might not give you much time to stretch out the distributions, but it probably would be better than paying all the taxes at once.

Another exception, which doesn’t appear to apply in your case, is if the IRA named the trust as the beneficiary. If that were true, “it is possible that the distributions could be based on the life expectancy of the oldest trust beneficiary,” Luscombe noted.

As you can see, this is a complicated area of estate planning and taxation. Getting good advice about how to name beneficiaries for your accounts can save your heirs a lot of money.

Delay collecting Social Security for a bigger benefit

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Dear Liz: My spouse started collecting Social Security in 2002 at age 63. I am 59, and not working, so my future benefits are unlikely to increase very much, even if I wait until age 70. If he dies before I do, will I get same amount he would be collecting at that time? If I collect Social Security at 62, would Social Security combine our records to calculate my benefit? In other words, should I try to wait or just start collecting at 62?

Answer: Your presumption that your benefit wouldn’t increase much by waiting is incorrect. Even if you aren’t working now, your benefit amount will grow the longer you can wait to apply. That’s true whether you ultimately get benefits based on your own work record or your husband’s.

When you apply, the Social Security Administration will compare your earned benefit with your spousal benefit and give you the larger of the two. Your spousal benefit starts at half of what your husband’s benefit would have been at full retirement age. That amount is reduced significantly if you apply for benefits before your own full retirement age (which is 66 for you, although it rises to 67 for anyone born after 1959).

Also, if you apply for spousal benefits before your full retirement age, you wouldn’t have the option of switching to your own benefit later, even if your benefit grows to a larger amount than what you’re receiving based on your husband’s record.

When your husband dies, you can switch to survivor’s benefits, which equal what he was receiving. Since he started benefits early, however, his checks have been permanently reduced to reflect that early retirement. In other words, if he had waited longer to retire, you would have been entitled to a larger survivor’s benefit.

The Social Security system is designed to reward people for delaying retirement, which is why it often makes sense to do so.

Get a second opinion before buying annuity

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Dear Liz: Our advisor recommended that we convert our rollover IRA to an annuity. We are having difficulty researching this. Any suggestions?

Answer: Unless your advisor is a complete numskull, he probably didn’t mean you should cash out your IRA to invest in an annuity. That would incur a big, unnecessary tax bill.

The idea he’s trying to promote is to sell the investments within your IRA, which wouldn’t trigger taxes, and invest the proceeds in an annuity.

The devil is in the details — specifically, what type of annuity he’s suggesting. If he wants you to buy a variable deferred annuity, you should probably find another advisor or at least get a second opinion. The primary benefit of a variable annuity is tax deferral, which you’ve already got with your IRA. The insurance companies that provide variable annuities, which are basically mutual fund-type investments inside an insurance wrapper, tout other benefits, including locking in a certain payout. Those benefits come at the cost of higher expenses, which is why you want a neutral party — someone who doesn’t earn a commission on the sale — to review it.

If he’s suggesting you buy a fixed annuity, which typically provides you a payout for life, you still should get that second opinion. A fixed annuity creates a kind of pension for you, with checks that last as long as you do. There are downsides to consider, though. Typically, once you invest the money, you can’t get it back. Also, today’s low interest rates mean you’re not going to get as much money in those monthly checks as you would if rates were higher. Some financial planners suggest their clients put off investing in fixed annuities until that happens, or at least spread out their purchases over time in hopes of locking in more favorable rates.

You can hire a fee-only financial planner who works by the hour to review your options. You can get referrals to such planners from Garrett Planning Network, http://www.garrettplanningnetwork.com.

How to get an ex’s Social Security information

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Dear Liz: I am 63 and divorced after being married over 10 years. I was told by our local Social Security office that I need my ex’s Social Security number in order to find out whether spousal benefits based on his record would be more than benefits based on my own record. I have his full name and date of birth, but I would rather not ask him for his Social Security number. If I do really need that, do you have any suggestions? Would some other type of information suffice?

Answer: The information you received from your local Social Security office is incorrect. You do not need your ex’s Social Security number to apply for spousal benefits, said Jonathan Peterson, AARP executive communications director and author of “Social Security for Dummies.” The more identifying information you can provide, the better, but the Social Security Administration can track down his records without it.

That said, you might want to dig around in your old files to see whether you can find a joint tax return, which will certainly have his number, or an old health insurance card, which might.

Spousal benefits are available to divorced people as long as they were married at least 10 years, are 62 or older and are currently not married.

How spousal benefits work

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Dear Liz: My wife has never worked outside the home and therefore has no Social Security credits. My understanding is that as a nonworking spouse, she is entitled to 50% of my benefit, assuming she is 66 years old and I have started receiving benefits. Is that correct?

Answer: You’ve got the right general idea. But spousal benefits are available to working spouses as well, your wife has the right to start benefits earlier (at a discounted rate) and you don’t have to actually receive checks for her to get this benefit.

Your wife is eligible for a spousal benefit based on your “primary insurance amount.” That’s the amount you would receive at your normal retirement age, no matter whether you’ve actually attained that age or started benefits. Normal retirement age is currently 66, but it will rise to 67 for people born after 1959. If she waits until her own full retirement age to start benefits, then she can qualify for a benefit equal to half your primary insurance amount. If she starts earlier, the benefit is permanently reduced.

If your wife had worked and qualified for her own retirement benefit, the Social Security Administration would give her whichever benefit paid the most — her own, or a portion of yours.

Because you’re still married, your wife wouldn’t be able to start spousal benefits until you’ve claimed your own benefit. However, if you’ve reached your full retirement age, you have the option to “file and suspend.” That means you’d file for benefits but immediately suspend your claim. That way, your benefit could continue to grow while she could begin receiving her payments.

If you were divorced but had been married at least 10 years, she could begin her benefits without waiting for you to file for your own. That exception was put into place so people wouldn’t have to seek their exes’ cooperation to get benefits.