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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.

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.

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.

Retirement Ahead

How Do You Determine Retirement Needs Accurately?

Here are the U.S. statistics on how workers plan for retirement:

  • 3% don’t have any idea
  • 47% do their own calculations or use a financial adviser
  • 50% just guess

To help you avoid guessing, I offer two different ways to approach how to calculate retirement needs accurately.

First method:  

  1. Estimate how long your parents and grandparents have lived.  Average the results.  This gives you a fairly accurate age you can expect to live.  In this example, let’s say it’s 83.
  2. Determine the minimum income you will need to live comfortably.  Let’s say it’s $3,000 per month.
  3. Subtract what Social Security is slated to pay and any pensions or other monthly income you can count on. In our example, let’s say it’s $2,000 per month. That leaves $1,000 per month you need on top of these payments for retirement.
  4. Subtract your age at retirement from age 83. In our example, this means you will need $216,000 for retirement.
  5. Divide the total amount needed to be saved by the number of months you have between now and the time you retire and this will give you a fairly accurate amount you need to be saving monthly.  In our example it looks like this:

Math: 65 (retirement age) – 40 (current age) = 25 years left to save; multiple 25 years x 12 months = 300 months; divide the 300 months you have between now and the time you retire by the total amount you need to retire of $216,000 = $720 per month you need to be saving

Second method:

  1. Calculate where all of your income might come from, and then build a spending plan around that amount.  For example, if you will receive $1,850 a month from Social Security, and $400 a month from a pension, along with $800 a month from a rental property, then build a spending plan around $3,050 per month of income.
  2. Adjust your plan to take into consideration variables that you cannot foresee right at the moment. For example, what if you live to age 89 and not age 83, or if you get sick and need medical care costing $23,000? Be thinking about unknowns and build some extra money into the spending plan to allow for them.
  3. Build into the plan how to pay for such things as the following:
  • Long-term care costs
  • Liquidity for emergencies
  • Inflation

If all of these factors require you to work longer than expected, it is better you know today and not find it out in 25 years! For specific help contact me at peter@moneymastery.com.

Social Security: Will It Be There for You?

Answer to this big question:  Since you pay 7.15% of your income to FICA, you have a right to receive what you pay for, right? So will the money be there when you need it?  My answer is a well-educated guess:  

You will get some benefit, but not even close to what is being projected. 

The reason I give for this is because we cannot possibly afford all that we have committed to our Gross Domestic Product (GDP).  The Congressional Budget shows that our statutory commitments, meaning what is already law, commits our total GDP to these prior agreements, all since 2009.  This is seven years of commitments larger than available money.  How can the government possibly keep this going and expect to pay out full Social Security benefits?

The point I am making is YOU need to save money and stop counting Social Security — become independent from any government benefit.  If you do receive some amount of Social Security income, then great — you will be both surprised and happy.  But to plan your retirement around this income is foolish in my opinion. Make changes today, to create a cash surplus that can make you more. For information on how to do this, contact me: peter@moneymastery.com.

Answers to Important Questions You Need to Know for Retirement…

What follows are 9 questions centered around my experience over four decades of helping people plan for retirement.  They are varied and don’t necessarily hook together, but they are quick and to the point.  See if they help you.  

  1. Are people shocked with taxes to be paid when they retire?  Yes, and no.  Some people have not accumulated very much money for retirement so taxes will not be an issue.  But for those who have saved all their money into a 401(k) plan, they will see taxes going from 15% to 25% when they add their Social Security benefits on top of earnings.
  2. What happens to people’s retirement funds when they reach age 70 Once a person reaches age 70.5 years old, they are required to take money out of all deferred accounts, like a 401(k).  This percent of balance grows as they get older so by age 80 it is close to 12% of the balance.
  3. Why should retired people stay below the 15% tax bracket?  Because this is the first level of tax, and it goes up to a higher bracket once a person reaches $75,000 annual income.  So if a person gets close to this level, it’s best to find a way to pay tax deductible items before the end of year so you don’t bump up into the 25% bracket.
  4. When should a person consider a Roth IRA?  Tax planning means to know where your level of income will be and convert funds from a deferred account into a Roth IRA years before you retire, and do it systematically so the amount you convert is low as you can get it, but still get the job done.
  5. Some folks have been able to save in a regular bank account, mutual funds and tax deferred accounts, like 401(k)s.  Where should they take their income at retirement from first?  It is best to even out your taxes over the years.  If all you do is defer everything, then at retirement and especially when age 70.5 arrives, the taxes will be much more than normal.  This really hurts to get to retirement and have to ask yourself, “Why didn’t anyone tell me about this before now?”
  6. What are some surprises most people find out at retirement People find they must have a spending plan (this is not a budget), or they will run out of money.  Up until retirement they could get along, wing-it a little because they might get a pay raise or a bonus or a large tax refund that gave them extra money to do fun things with.  But at retirement those extras go away unless you plan for them in your spending.
  7. What other surprises might someone find at retirement?  The biggest problem I see when people retire, then spend some money their first year, is that they find that within 7 years they will be totally out of money.  They kind of know this, but it hits them hard after the first year in retirement.
  8. What can a person do when they see they will run out of money in 7 years? They can slow their spending, get a part-time job making extra income, or sell an asset, and possibly get a reverse mortgage on their home to pull out extra money and turn this into income.  Many other ideas are available, but you will have to get creative. I suggest you contact me for some really great options that most other advisors will never tell you about:  peter@moneymastery.com. 
  9. Would you be willing to answer more questions that arise out of this retirement discussion Of course! It is hard for people to work at a job and learn all the rules about retirement.  They work hard and come home tired and the last thing they want to do is research tax code or call creditors. All I do is study various options surrounding the retirement decision so I can bring you lots of examples and ideas tailored to your specific situation so you won’t arrive at retirement broke, or run out of money in only a few years.  Call me or email:  (801) 292-1099, peter@moneymastery.com for a no-cost consultation.

How to Prepare Financially for 2017

Goals are helpful but everyone always complains about how hard New Year’s resolutions are to keep.  So what can you do to make the New Year financially successful and ensure that goals you set in January don’t end up on the back burner by February?  Here are some of my thoughts about money and personal organization that can bring a lot of success to your financial life in 2017:

New Year Challenge: During the first month of the year, sit down with your spouse and start the discussion by announcing that you are dead, at least on paper. Then begin asking him or her the following thought-provoking questions and see how many of them they can answer without any prompting from you. This little exercise will reveal just how organized you are financially (oh, and how well you can communicate about such things).

  1. How much life insurance do I have on my life?
  2. Where is the policy?
  3. Who is the agent to call and report my death?
  4. How much debt do I have?
  5. Will you have to sell the house or refinance the mortgage, and how do you find out which you will need to do?
  6. Do I have any savings or safety deposit boxes?
  7. What investments do I have?
  8. Do I have a will or trust?
  9. How long will it take to clear assets and take ownership of the trust
  10. Who is the executor of my estate?
  11. Do I have a burial plot paid for?
  12. Does anyone owe me money, and how can you find out?
  13. Where do I keep my tax returns and who prepares them?
  14. Does Social Security pay a death benefit to you upon my death?
  15. How much will Social Security pay you when I die, and why/when?
  16. What attorney should you use and what will be his/her average costs to settle the estate?
  17. Where will the funeral be held and what will it cost?

Now you may be thinking that some of these questions most couples would know the answer to, together. But you might be surprised by how many spouses stay completely out of the finances and let the other partner handle everything. When their spouse dies, they have no idea what to do or what problems they may have to handle.  Asking these questions gets you both thinking and gives you a chance to review exactly what each partner knows or doesn’t know and what needs to be done to get on top of things financially so BOTH people are taking responsibility for the financial success of the marriage.

I urge yo to take this challenge in the New Year as a catalyst for getting completely and totally organized financially. For more ideas on financial organization, contact me at peter@moneymastery.com. The Money Mastery Master Planner organizational system I use personally and with my clients will totally change your life and help make 2017 the best year ever!

Your Retirement Situation May Not Be as Bad as You Think…

I have good news and bad news. Okay, here’s the bad news:  According to the Economic Policy Institute’s retirement study of 2016, the average amount saved for purposes of retirement is only $5,000.  This is catastrophic when you consider that the actual amount of money needed to retire is five times your annual salary. 

Now the good news.  It has two parts to it: 

  1. If you subtract out of this dismal statistic anyone who has saved nothing (or this measly $5,000) for retirement, the average amount saved for retirement jumps to over $65,000.  Okay, this number isn’t all that great either, but it’s a whole lot better than $5,000.
  2. Add to that $65,000 a Social Security benefit.  This income replaces 65 percent of a $30,000 annual salary.  Okay, so Social Security is not going to be much for a person who was making $120,000 annually when working because that benefit equates to only a 28 percent replacement. But, and this is important, a person can still live okay on 65 percent of a modest working income in retirement. Those who have not planned for retirement who have earned a bigger annual salary are going to have to cut way back on what they’ve been used to doing and living on if all they have is this Social Security benefit to count on. But the point is, a person can still manage on a smaller amount. Obviously, if you are one of the people who has never had a large annual salary in your life, then it won’t be as big of a stretch.

I give this encouragement with a small caveat. We don’t really know what’s going to happen to Social Security going forward. The federal government informs us that the fund will be defunct in about 15 years, so those who retire later without having planned may not be able to count on this Social Security benefit.  However, for the first wave of Baby Boomers who are now retiring, it looks like they may be able to get by if all they have is Social Security and at least $65,000 in the bank.

The bigger point I’d like to make is that rather than just get by, why not learn how to be a saver right now so you can have more than just a modest retirement that is in constant jeopardy?

Here are some simple steps to take RIGHT NOW that can change your retirement outlook in just a few short years:

  1. Learn how to control spending to the point that you have a cash surplus each month. The only way to do this is to create a Spending Plan (this is not a budget). Now you just jumped out of the “average retiree” pool and into the “I’ve got something to work with!” pool.
  2. Within that Spending Plan, create a spending category for savings. This is where you will track each month what you pay to yourself in the form of savings. Initially maybe all you can pay yourself is 1% of your monthly income, but your goal is to work up to 10% each month.
  3. Next you will create a Debt Plan where you can eliminate all your debt (including your mortgage), which is mathematically possible for anyone, no matter how bad their debt is, in 10 years or less. As you get out of more and more debt, you will apply these debt payments to your “savings” category in your Spending Plan, increasing the amount you can accumulate towards retirement rapidly.
  4. Finally, you will create a Retirement Plan, where you can learn just exactly how much money you need to be saving in order to create a predictable retirement you cannot outlive.

Now who doesn’t want that kind of retirement as opposed to one where you can get by, but barely? To learn more contact me for a no-cost consultation. I would be happy to give you more information about how to truly prepare for retirement, whether  you have five years or 35 to do it:  peter@moneymastery.com. And be sure to visit www.moneymastery.com for more information.

Retirement Questions Answered by an Experienced Financial Adviser

Are people shocked with the amount of taxes to be paid when they retire?  Yes, and no.  Some people have not accumulated very much money for retirement so taxes will not be an issue.  But for those who have saved all their money into a 401(k), yes, they will be very shocked when they see taxes going from 15 percent to 25 percent whenTaxes they add their Social Security benefits on top of everything.

What happens to people reaching age 70?  Once a person reaches age 70.5 years old, they are required to take out money and pay tax on all deferred accounts, like a 401(k).  This percent of taxes to be paid on the balance grows as they get older so by age 80 it’s close to 12 percent of the balance.

Why should retired people stay below the 15% tax bracket?  Because this is the first level of tax, and it goes up close to the $75,000 income range.  So if a person gets close to this level, it’s best to find a way to pay tax-deductible items before the end of year so as not to be bumped into the 25 percent bracket.

When should a person consider a Roth IRA?  Tax planning means to know where your level of income will be and convert funds in a deferred account to a Roth IRA years before, and do it systematically so the amount you convert is as low as you can get it, but still get the job done.

Where should I take income for retirement first, a regular bank account, mutual funds, or a tax-deferred account like a shutterstock_128683532 (534x800)401(k)? It is best to even out your taxes over the years.  If all you do is defer everything, then at retirement and especially when age 70.5 arrives, the taxes will be much higher than you have paid in the past.  This really hurts to get to retirement and have to ask yourself, “Why didn’t anyone tell me about this before now?”

What are some surprises most people find out at retirement?  People find they must have a spending plan, or they will run out of money.  Up until retirement they could get along, wing-it a little because they might get a pay raise or a bonus or a large tax refund that gave them extra money to do fun things with.  But at retirement those extras go away unless you plan for them in your spending.

Anything else that may surprise people reaching retirement?  The biggest problem I see when people retire, then spend some money their first year, is finding out that within seven to eight years they will likely be entirely out of money!   They kind of know this, but it hits them hard after the first year in retirement.

What can a person do when they see they will run out of moneyscreen-shot-2016-09-16-at-2-31-17-pm
in 7 years at retirement?
  They can slow their spending, get a part-time job making extra income, sell an asset, or possibly get a reverse mortgage on their home to pull out extra money and turn this into income.  Many other ideas are available, but a person will have to be creative, and will need help from an experienced financial coach.

Will you be willing to answer my personal questions about retirement?  Sure! It is hard for people to work at a job and learn all the rules about retirement.  They work hard and come home tired and the last thing they want to do is do research on tax codes or call creditors and ask what happens when they retire. All I do is study various options surrounding retirement decisions and have coached thousands of people on how to apply these options wisely and responsibly for the past 35 years; this is my life and I’m happy to share my knowledge with you. Contact me today for a no-cost conversation:  peter@moneymastery.com. I will bring you more examples and ideas to the table of how to make income work, even if you think you might arrive broke at retirement.

What Will You Do about Money If You Live to Be 100?

Experts think that any of us living today, who reaches age 65, healthy and vibrant, will easily make it to age 100.  Whoa! That will change things financially, to say the least.  In the “old days,” between 1960 and 1980, people who reached retirement age lived just four to eight years past retirement to about 69 for men, and 72 for women. It wasn’t too big of a stretch to have between five and 10 years of retirement income saved . But consider working 35 years, then retiring for 35 years instead of just 5 to 10.  I read an article in 1983 that said by the year 2000, many people would be retired as long as they worked. At the time I balked at that idea — NO WAY! I thought. But the fact is, those numbers are a reality now and that longer retirement period is presenting some very challenging problems we all need to think about:

  1. How will you afford to live 35 years into retirement? 
  2. Will you need to work more years than you had originally planned, until age 75, for instance? What if you can’t because of poor health?
  3. Will you have to reduce your living costs drastically to make ends meet?
  4. What about inflation? If the inflation rate keeps averaging 5 percent screen-shot-2016-09-16-at-2-31-17-pmper year as it has been doing, living on a fixed income for 35 years is not going to work very well.
  5. People may be living longer, but especially in the United States, where the standard American diet is so poor, you won’t be living to
    a ripe old age in good health. What if you’re one in four people who will require long-term care? This is expensive at between $2,500 and $6,000 per month.
  6. Social Security will be bankrupt in 2034, according to the Social Security Administration’s annual report, so what do you do if you can’t count on even that income in retirement?
  7. If you are one of the many retired persons who is divorced, what will you do to live on just one retirement income instead of two?

The old way of looking at retirement planning may not work for you anymore. Trying to save using a basic 401(k) is passe. It’s time to get creative and look at real estate, life insurance, annuities, and leasable resources as other options for creating a predictable retirement you can’t outlive. I suggest you read the book MONEY, What Financial Experts Will Never Tell You Full of case stories and practical, holistic approaches to financial planning and retirement that are easy to apply, this book is a BookCovermust-read. Get it in time for Christmas and give it to your kids as well. They will for sure be living longer than you, in most cases, and will have to be ready for a long retirement period. Why not prepare them for that now?  Get going, as time will keep marching forward. Will you be pleasantly surprised when you reach retirement age, or will you be horrified and shocked at what you have done to yourself financially by not taking things seriously today?