When, Why and How Do Social Security Benefits Become Subject to Income Tax?

Social Security was established in 1935, due to so many elderly people going hungry during the Great Depression.  President Roosevelt felt people were losing hope.  The Welfare Department was established and Social Security began.  In the past, FICA tax paid into the Social Security system on a portion of income was never subject to income tax.

With that historical background, now let’s take a closer look at Social Security today and how it works 75 years later. I have researched over 50 of my clients at all ages by examining their Social Security benefits statement and this is what I’ve found:  The average portion that you will have paid into FICA tax during your working life will be close to $43,000.  Using the monthly income that the government promises to pay you for your lifetime, I have found on average that within two years you will have received all $43,000 back into your pocket.

Now what if you made a lot more money, thus had to pay more in FICA tax?  Your benefit will be higher, of course.  But you will still
have received back all that you paid within about two years.   Now does your Social Security benefit stop after you receive back everything you put into the system? Of course not, and if you, me, or anyone else lives to today’s average life expectancy of 84 for men and 87 for women, you will receive over $400,000 in Social Security benefits!  This could be considered the Social Security deal-of-a-lifetime:  Pay in $43,000 over 30 years and get back about $400,000 over 20 years.  This is the best pension deal anyone has ever had! 

But, and it’s a big but, Congress never planned on this happening when it instigated the Social Security system.  In the 30’s, 40’s and even 50’s, most people retired at age 65 and died five to 10 years later. But that started to change in the 1960s and today has exploded into this huge payout.

How can the government afford this?  The answer of course is it can’t!!  When Congress voted to cut benefits in the early 1980’s to deal with the problem of a huge payout it could not afford, citizens pushed back hard and the effort to cut Social Security was abandoned. Then someone suggested the government tax Social Security benefits to help make up the drag on the system, and thus Social Security income is now subject to tax. All retirees get their same Social Security income and since so few people actually check their tax returns, no one seemed to be pushing back on this new tax law. But with that change, retired people instantly lost 20 percent of their income without even realizing it. 

With that historical perspective, let’s now look at what that means for you today using the Social Security tax rules as of 2015 using the base amount showing on your tax return as “Modified Adjusted Gross Income”:

Single: $25,000 – $34,000, then 50% of Social Security is subject to income tax.  If income is greater than $34,000, then 85% of your benefits become subject to income tax.

Married Filing Jointly:  $32,000 – $44,000, then 50% of Social Security income is subject to income tax.  If income is greater than $44,000 then 85% of your Social Security benefits become subject to income tax.

Here is the bad part of this formula.  You have to use one-half of your Social Security benefits to establish your base income for this formula.  Example:  A person receiving $1,800 a month from Social Security multiplied by 12 months = $21,600.  Half of this, $10,800, must be included as income, which could force Social Security benefits to be taxed. A person can only earn up to $25,000 from all sources or benefits will be taxed.  Retirement income from IRA or 401(k) accounts can easily exceed this amount,  so when someone is so proud they saved a lot of money in their tax-deferred 401(k) plan, they just assured themselves of getting a haircut on their Social Security benefits.

Congress has deceived us, in my opinion.  Hindsight says they should have just told us they will reduce benefits according to the length of life.  If they would have done this in 1950, or 1960, or 1970, there would not be such a problem today.  Watch out for changes, because the government can NOT keep paying out this much money to all the Baby Boomers retiring at the rate of 10,000 each and every day. 

A potential solution for you is to convert any tax qualified savings accounts like IRAs, or 401(k)s, to a Roth IRA, which means you have to pay income tax when you do the conversion, but once converted, this money will never be taxed again.  So it is better to convert early in your life so that the growth does not compound your income taxes and force your Social Security benefits to be subject to income tax.  This effort will take planning, organization, knowing the rules and controlling your spending to have enough money to pay taxes today and not allow investments to grow tax-deferred and crush Social Security benefits at a time when you really need them the most. If you need more help, contact me:  peter@moneymastery.com.

Know Your Plan Before You Die…

Most employees do not know what their Social Security benefits will be.  They don’t know what their 401(k) will provide for them at retirement, nor when they will be out of debt.  Few employers provide disability insurance if you get hurt or sick, so what will happen if you become sick or hurt?  And health insurance is a “can of worms.”  If you are self-employed, and/or running a small company, many more questions exist than there are answers.  What will you do when you die or your spouse does?

Everyone should know what benefits they are going to enjoy, and communicate with a spouse about them at least annually.  Things change so fast that if you think you have benefits and don’t, you can go broke in a single week!  It is not hard to gather all your financial information together and review it.  When you have a question, make the effort to call and get answers. 

To see how this works in the real world, I want to share one of my client’s stories:

The husband passed away suddenly at age 64 and his wife had never worked outside the home.  He had $20,000 of group term life insurance and they had $52,000 savings in a 401(k) account.  Their home was worth $230,000, but they still had $189,000 mortgage.  The wife is in good health and expected to live beyond the average life expectancy for women of 87.  The husband’s funeral cost $15,000.  The wife has the option of accessing Social Security benefits of $1,245 a month, or to wait another three years and get $1,570 a month.

What would you do in this situation?  Their monthly living expenses before the husband passed away had been $4,000 per month. Now there’s no money to live like that. Will the wife have to sell the house since the Social Security income she could take now will basically pay the monthly mortgage and that’s it?  If she does sell, where will she live and what will she live on?

This couple had not talked about early death or how one or the other would live once one of them passed away — there was never this kind of detail discussed, ever. They just went along thinking nothing would change.  But it did change and the woman in this situation is in a really bad place financially.  And it will change for you too.  It is only a matter of time before big changes come to your world.  Get prepared.  Review all your benefits and make decisions today as if one of you has passed away.  Play this game over and over until you feel comfortable that you have your financial situation right.

In my experience, most people die with nothing more than a simple will. Their assets have to be probated in court until they are cleared for distribution.  This can take two years.  The expense of having a judge decide how to divide up assets can drain another $30,000 off your assets.  And in many cases, the surviving spouse still needs an income to live on.  What if health problems arise?  

The best way to start preparing for coming changes is to stop spending any more money until you have a Spending Plan in place and have learned how to track that plan so you can see where you are wasting money. Once you do so you will find a surplus that you can begin saving. Fund your future with this real money, that comes from getting your spending and debt under control. Then make sure you create a living trust. Transfer your assets into the trust and make sure nothing goes to the court to decide. Go to www.easylegalplanning.com and see how simple it is to get organized and match assets with a real plan document.  Don’t delay and become part of the majority that leaves your family out in the cold, unable to help themselves.  The memory of you that will be left will not be good.  To learn more go to www.moneymastery.com or contact me: peter@moneymastery.com.

Beware of “Financial Plaque”… It Can Kill All Your Best Laid Plans

This illustration of plaque buildup in the arteries makes me sick.  Millions of people have plaque that has the potential to cause huge health problems.  The same can be said about the “financial plaque” that so many people carry around with them. They have allowed their spending to overcome their income and use credit almost exclusively to live on. When you consider the interest expense that accompanies this widespread use of credit, the damage can be just as detrimental as plaque in the arteries.

What kind of damage is debt doing to people?

  • No money set aside for emergencies, which are bound to occur.
  • No money set aside for emotional impulse spending, which is also bound to occur.
  • No hope of retiring, ever.
  • Lost opportunities to create wealth that puts money to work rather than working for money.
  • Lost opportunities to help those in need, to create jobs for others, to form philanthropic organizations.
  • Almost certainly guaranteeing problems paying for healthcare in old age.

The remedy for plaque and heart disease is to eat properly, exercise, and get plenty of rest. Financially, the remedy is to build a Spending Plan and track expenses according to that plan in order to create a cash surplus.  Saving that surplus is the same as getting plenty of rest for the body. 

Learn to put work clothes on your savings and send it out the door to work instead of working your entire life to pay off debt. This will bring not only financial health, but physical health and happiness as well. 

To find out what’s building up in your “financial arteries” visit www.moneymastery.com. today.

The Power of Emotional Savings…

A friend of mine loves to golf.  But the expense of it is concerning to his wife so my friend won’t tell his wife when he goes and even leaves his golf clubs with his friend permanently, just so his wife doesn’t see them missing for a day.

I use this example of golfing because it is so common.  It isn’t just the expense, but the time away from work.  It takes me four hours to play a round of golf.  Since my friend is in sales, when he golfs he loses four hours he could have been earning money he can bring home to the family to help get their financial situation under control.

What about a client of mine who loves to get her nails done? She pays to have her nails decorated to match the seasons of the year and will spend as much as $35 for “themed” nails for Halloween and Christmas. And of course she lies to her husband about the cost by saying her friend paints her nails so there’s no cost.  

But is golfing bad or going to the salon such a terrible thing? Of course not! We all need to relax at times and to pay for items that make us feel good about ourselves. The problem is when we have not planned for such expenses. By building a spending plan that includes Emotional Savings you can have the things you want as well as the money you need for necessary expenses. On top of that, you won’t have to lie about these things to your partner!

Along with long-term savings for retirement and emergency savings, build into your spending plan extra “mad money” if you will.  It is inevitable that you will spend this kind of money sometimes, so why not have a plan for it? And be sure to build in this mad money for your spouse as well, not just yourself, even consider doing it for children. In my experience we all need some fun money, regardless of age. We need to know that after all the hard work we do, there will be some kind of reward waiting for us. When you build this kind of money into your spending plan, you will be less likely to go into debt for such items, and will stay on track to save for the future more successfully.

Best of all, this kind of planning makes it possible to have open, honest relationships with the ones you love. You can hold a weekly “Money Huddle” where you discuss finances with your partner without fear or embarrassment and this helps build relationships and brings you closer together. In such meetings you can talk about how the golf game went, for example, or what kind of colors you want to put on your next nail painting. Can you see how this eliminates all the drama?  Emotional spending and weekly money huddles can go a long way to solving financial problems. For help in creating a spending plan with emotional savings built into it visit www.moneymastery.com today.   

Retirement Can be Like a Rose, Depending on How You Hold It

A rose is beautiful and we all enjoy them to celebrate special occasions.  But roses have thorns — sometimes we can prick ourselves if we aren’t careful.  Retirement is just the same.  We can enjoy retirement if we hold it just right, but if we refuse to prepare, the thorns we will experience in retirement can cause some real pain.

Here are some of those thorns to consider:

  • Of all people who filed bankruptcy in 1991, 21% were older than age 65. Today that number has grown to 28%.  This destroys credit and prevents ability to borrow money for needed items. If debt levels are really high before retirement age, this can be a real thorn to manage after age 65.
  • Some parents try to help their children with student loans by co-signing on federally insured loans. Later, if the child doesn’t get employment that earns enough money, the parents end up paying on the loan.  This can be a real thorn when it comes to retirement.
  • Another potential thorn in retirement is higher taxes. No doubt you have been taught to save money in a 401(k) or other tax-deferred savings program throughout your working years. Supposedly you will be in a lower tax bracket in retirement years so paying all those deferred taxes in retirement will be cheaper than paying them during working years. But it has been my experience working with thousands of clients that this simply isn’t the case. People in retirement usually pay much  higher income tax than when working because they don’t have any deductions!
  • Another thorn that can cause real pain in retirement is waiting too long to start saving for it.  If you started working at age 25 but did not form a habit of saving until age 55, this could potentially pain you every day of your life in retirement.
  • Having to work until age 80, because you don’t have enough money to retire, can be another real problem.  Maybe you like to work and you don’t mind it. But that’s different from being forced to work. And what if you don’t have the health to do so?
  • What about the fear of running out of money in retirement, which oddly enough, is a much greater fear than dying? I’m sure the reason is that it’s hard to cut spending down at a time we have more free time to spend.  Statistics show we spend more when we first retire than when working.  Apparently it takes a few years to adjust to the new income.
  • The thorn of inflation is real.  It has hurt so many retirement-aged people as their fixed expenses increase while their income does not.
  • The final thorn that can turn a beautiful retirement into a thorny nightmare is the need for dental, vision, hearing and for long-term or hospice care.  The huge prick here is that the costs can exceed your entire savings for retirement, and this might leave a surviving spouse destitute and on welfare.  A HealthView Services study in 2016 shows that the cost for all these elderly care service for a couple age 65+ will be $377,000 during their retirement.

To create a beautiful retirement with minimal thorns, get in touch with a financial coach who can teach you how to deal with each of the things I have discussed above. Contact me today: peter@moneymastery.com.

Smooth Sailing in Life Won’t Happen, But Things Can Still Be Great with the Right Attitude

The illustration below shows how we all want our finances to go, smoothly all the way until we reach our financial goals. However, “life” happens and then we have the picture below it with all kinds of obstacles and bad weather, sketchy bridges to cross and danger all around.


How can we manage chaos, the never-ending changes, or surprises throughout our life? Many people manage very well, so I got curious and set out to interview over 100 of our most successful Money Mastery clients and here is what I found:

  • They are positive thinkers.
  • They believe good things will come out of everything bad.
  • They love rubbing shoulders with other positive thinkers, even seek them out.
  • They thrive on adversity and don’t shrink away from it necessarily.
  • They make lemonade out of lemons.
  • They prepare in advance for the unseen events that can unfold.

An example of this kind of positive thinking is Jack Simplot, growing potatoes in southern Idaho, and raising a couple thousand head of cattle. Jack had to get creative about what to do with all his potato peelings after environmentalists almost shut him down, so he tested his cattle on eating the peelings. It worked, as they ate the peelings and thrived. Today many people purchase his Ore-Ida spuds in a box.

  • They don’t mind taking risks.
  • They don’t run unprepared into trouble, but they do take thoughtful and calculated risks.

An example of this are the pilgrims leaving England in the 1600’s for religious freedom. “One doesn’t discover new lands without consenting to lose sight of the shore, for a very long time,” the author Andre Gide once said.

  • They are comfortable in their own skin.
  • They don’t mind the scrutiny of others, because they live their life with integrity.
  • They look out for others less fortunate than themselves.
  • They are givers, leaving behind far more than what they were given when they started.

A very good example of this is Mother Teresa. She helped thousands of sick and poor people along her way.

So, do you want smooth sailing throughout your life? It won’t happen that way, but you can have a wonderful life both financially and in your relationships by embracing these tried and proven approaches to life. I had a wonderful experience interviewing my Money Mastery clients about what makes them successful and making notes on what they taught me. I am much more positive and have a different outlook today because of this effort. Hope you do too.

When Did the Concept of “Retirement” Come to Be?

As you can well imagine, the idea of “retirement” did not exist in Roman times, nor medieval times, and certainly not when Pilgrims discovered America.  What about during the days of Lewis & Clark?  Or when the wild West was being settled?  History teaches us that a Roman peasant had to fight for food every day of their life.  A peasant could not even fathom taking life easy, sitting back to watch the evening news, or going out to eat and taking in a movie. How could an English Lord even conceive of “retiring?” He had to manage a kingdom and train new knights to protect him and his vassal serfs.

Some examples of newly created words, along with the idea of “retirement” in the last 100 years include:

  • Internet
  • World wide web
  • iPhone
  • Light bulb
  • Polyester
  • DVD
  • Contact lens

We have seen so many advances in technology and medical care in the last century that we have a lot more time on our hands than anyone born before the turn of the last century. That extension of life plus all that time we have available has been the reason the idea of retirement even exists.  “Retirement” is a new concept, only around since just before World War II broke out. Up until 1920, most people died before they reached the age of 60, so retirement wasn’t even an option.  When people started to live past age 65, some elderly folks started to save money for when they could no longer work, and thus the concept of retirement was born.

Four problems came along with this new concept. The first problem is outliving your income. Today 92 percent of everyone who is retired is totally dependent upon their Social Security benefit.

A second huge problem is inflation.  Just use your Web browser to see what one gallon of milk cost 20 years ago and you will be shocked.  You will most likely need to double the money you think is needed at retirement, because of inflation.

A third problem is continual taxation.  As you take money from you retirement savings plan to live, this income is taxed and can cause Social Security benefits to be subject to income tax as well.

A fourth gigantic problem is the cost of medical, long-term care and nursing home expenses.  The national average shows costs for a retired couple for medical/nursing care is $250,000 before they die.  This kind of cost is eating up all possible savings most people manage to squirrel away for retirement.  When all resources have been exhausted, the surviving spouse becomes destitute and is classified as being on welfare.

Considering these four problems, now is the time to decide what “retirement” means to you and whether you will be able to make that vision a reality. You have heard about the importance of planning for retirement your entire life, while those who lived before 1920 did not even have an inclination of what that meant. Before it’s too late, define what you want to happen when you reach age 65 because unlike your grandpa and great grandpa you will likely live longer than 60 years, so you will need to be prepared for that long life and how you want to live it.  It’s never too late to get going on this.  Go to moneymastery.com and sign up for the Basic online training package and see for yourself how much money you need to be saving for retirement, or calculate how long your money will last. For more help, contact me directly: peter@moneymastery.com.

Know the Rules about Your Privacy… Or Lack Thereof

Money Mastery Principle 5 teaches: Know the Rules. In this post, I will illustrate the importance of knowing the rules when it comes to your financial privacy.

Following is a redacted privacy policy that you will notice is pretty much the same as every other privacy statement you have ever come across.  At the top the publisher will reference federal law that gives consumers the right to limit sharing of their personal information, “but not all sharing.”  

What this means is that federal law allows marketing to you at every level unless you know the entity’s particular rules of privacy and take action against them.  Examine this privacy notice and you will see you can only limit three things:

  1. “Our affiliates’ everyday business purposes;
  2. “Our affiliates to market to you; and
  3. “Non-affiliates to market to you.” 

Neither you nor I can maintain the actual privacy of our personal information!  Pretty much anyone can use your Social Security number and income, account balances and payment history, and transaction or loss history and credit scores.   This is horrible!

Okay, but you may say, “but look, they provide a phone number to call and ask to limit your information towards the bottom of the notice.”  My response to that is, “so what?”  Look at all the ways they can still share and sell your information off to so many other marketing organizations!!

Research shows that the vendor can sell your information off for some small fee.  Let’s use 17 cents for each purchase of your private information.  I use 17 cents because if you go to buy qualified information this is a standard rate that’s often used. Run the calculations:  This vendor sells your private information once a day for the entire year.  This means your personal information just paid the vendor $62 that year.  In other words, your personal Social Security number, income and payment history, and credit scores just made them a profit of $62.  Now can you see why you get so much junk mail?  Can you see why you get spammed and marketed all day long?

Can you do anything about junk mail offers?  You cannot stop them.  If you send the offer back as “return mail” and tell them to stop then they know this is a good address and will keep sending marketing materials.

Can you do anything about marketing offers through your email? You can block the sender and even report spam, but surely they are smarter than all that reporting.  All they have to do is move your personal information over to a new URL and start again.

What is the worth of federal law limiting your privacy?  I think it is not worth the paper it is printed on.  Nevertheless, I still make the phone calls and limit what I can and feel you should, too.  There needs to be more discussion and further legislation to prohibit this travesty. While not much can be done at this point, at least knowing the rules will put you in a position to take action and try to fix problems when the opportunity arises. Not knowing the problems prevents you from doing anything about them should the chance ver arise. 

Take Caution: Read Disclosure Notices on Investment Projections Before You Sit Back on Your Retirement Laurels

Following is a typical disclosure notice you might see at the end of an investment report. Take the time to read this disclosure,  you might be surprised what you find:

If a numerical analysis is shown, the results are neither guarantees nor projections, and actual results may differ significantly.  Any assumptions as to the interest rates, rates of return, inflation, or other values are hypothetical and for illustrative purposes only.  Rates of return shown are not indicative of any particular investment, and will vary over time.  Any reference to past performance is not indicative of future results and should not be taken as a guaranteed projection of actual returns from any recommended investment.

If you reviewed a report that said your retirement is going to be adequate but then get to the small print at the bottom of the report and it says, “Any assumptions as to the interest rates, rates of return, inflation, or other values are hypothetical and for illustrative purposes only,” how should you feel? How much credence can you place in the numbers from such a report when planning your future?  For example, if an assumed interest rate went from 5% to 3% in real time as you are saving for retirement, you might run out of money with 12 years left to live!

Or let’s say you use the past 40-year average market gains to forecast your future income and then read, “Any reference to past performance is not indicative of the future results.” You probably aren’t going to feel super confident about what your direction is going to be.

Of course we need to plan and project, using the best tools available, but how can you do any of those projections given all the unknowns?

In my experience, the best way to use forecasting projections is to keep track of each year’s projections and review from year to year.  As the years go by you can watch out for adjustments that will surely force some changes.  This way when something isn’t quite working out like you forecasted, you adjust. It’s the simple principle of tracking and you should be applying it when it comes to retirement funds, but what I have found is very few people do, only about 3 percent of us actually track and adjust each year.

Think of you being the navigator on an airplane.  As you fly from San Francisco to Dallas, you are seldom going straight to your destination because of wind and weather.  A navigator must keep adjusting and changing the course according to what affects the plane.  This is the same for each of us financially.  The forecasting is so important, but the adjusting to changes is critical.  So for the 97% of those who don’t forecast, they will not end up in Dallas, financially speaking, but probably Minneapolis.  I hope they like the colder north country. For information on how to create a more predictable retirement that you cannot outlive, contact me for a no cost consultation: peter@moneymastery.com.

What Happens to You Financially If Your Health Changes?

According to the Social Security Administration, 41 percent of all workers are required to retire earlier than planned due to a personal health problem — that’s four out of every 10 Americans. And the National Council on Aging has stated that about 91 percent of older Americans have at least one chronic health condition; another 73 percent have at least two.

What will you do if you’re one of the four out of 10 people who have to retire early?  How will you manage, and do you have enough money?  Get serious and create a plan based on the assumption that you might have this problem. After all, as stated above 91% of all seniors have a serious health problem — don’t gamble with those numbers and hope that whatever condition you get won’t keep you from working as long as you need to.  

Here are three things to do if you physically have to retire:

1.  Cut spending down to what money is available.

2.  Apply for Social Security benefits under handicapped status. This may take 6 months, but can help your income a lot.

3.  Stay mentally engaged with family, community and friends.

As you rearrange living expenses, this may lead you to consider downsizing your home.  This can help lower the cost of utilities and property taxes.  Think long-term when you are making these adjustments.

The Social Security administration has provided for those who get disabled at an age younger than 62.  This could be a source of income for the rest of your life.

When people finally retire, the most successful are those who stay actively engaged with the world.  They volunteer to make a contribution to the community around them.  By staying engaged, they are more alert and have a higher quality of life.

Plan for the event of bad  health and then if it doesn’t happen, you’ll still have the extra money plus you’ll have peace of mind, no matter what happens, and that is worth its weight in gold. peter@moneymastery.com.