Spousal benefits for Social Security is a complicated issue and can lead to the potential of leaving some money on the table.  Recently I hosted a webinar with BlackRock’s Michael Graci and we went over the topic of Social Security, how it works and what it means to you and your spouse.  Here are a few key items to know about Spousal Benefits for Social Security.

1. A spousal benefit is equal to 50% of their partner’s Primary Insurance Amount (PIA) once they themselves reach their Full Retirement Age (FRA).
2. When a spouse collects their spousal benefit can impact the total they take home. If a spouse collects spousal benefits before FRA, their spousal benefits will be reduced (please note that collecting five years early results in a 35% lower benefit). On the other hand, your spouse is not rewarded for waiting beyond FRA. Spousal benefits do not receive delayed retirement credits, so there’s no incentive to wait to collect a spousal benefit beyond full retirement age.
3. One spouse must file for their benefit in order for the other spouse to be eligible to collect a spousal benefit.  So if they are both the same age and  one spouse waits until 70 to file and collect, the other spouse must wait until 70 to collect the spousal benefit.
4. Individual benefits and Spousal benefits are netted against one another.  Your spouse will get the greater of 50% of your benefit or their own benefit.

The picture above shows the example of a husband and wife. Jordan has a Full Retirement Age benefit amount of $2,200, therefore if his wife Alex waits until age 66 and claims when Jordan claims she will get half of his benefit or $1,100. 

It is also important to note that when a spouse claims their spousal benefit determines what amount of benefit they will receive. If Jordan were to claim his Social Security benefit at age 62 and Alex, his wife does the same thing she will received a reduced benefit.  

Lastly it is important to note that if one spouse waits until 70 to claim their benefit this will not increase the benefit amount for their spouse. This benefit will still be based on 50% of their amount at Full Retirement Age. If that is the case it will make sense for the spouse to claim their own benefit, if possible, at Full Retirement Age to at least start receiving some benefit.

If you would like to schedule a call or zoom meeting to discuss what how you and your spouse can optimize your Social Security benefits Click Here

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The majority of American workers now saving into a company 401(k) plan for retirement. Within their 401(k) plan most employee contributions are made with pretax dollars and all employer match and profit sharing contributions are made with pretax money.  This is a great way to lower your income tax liability in the years that you are working and making the contributions. However, blindly putting money into a 401(k) plan using pretax dollars can lead to a long term spike in your and your beneficiaries income taxes. The solution to consider now is adding Roth savings, either through a Roth IRA or Roth 401(k), into your savings strategies. This can be done either by contributing or converting your savings.  Here are some reasons to consider that now.

1. Required Minimum Distributions can propel you into a higher tax bracket

A Required Minimum Distribution(RMD) is a withdrawal that everyone over the age of 72 are required to take from their pretax retirement savings. The only exception to this is non business owners still working and saving into their company 401(k) plan. The purpose of these distributions is for the IRS to start to collect tax dollars from money that has been tax deferred up to this point.  These withdrawals will add to the amount of taxable income that retirees will have. This number gets added on top of Social Security, pension income, rental income or any part time income one may have in retirement.  From my experience many retirees do not need these withdrawals to live off of.  These withdrawals can also make your Social Security payments taxable.  Roth IRA savings are beneficial to combat these withdrawals because they do not require RMDs.  By having more of your money saved in a Roth IRA vs a pretax IRA this will reduce the amount of your annual RMD.

As you can see from the chart above, once the process of RMD’s start there is a sharp increase that one will pay in taxes on an ongoing basis.  The RMD amounts slowly increase over time as the account balance also increases.  This can lead to spending your remaining years in a higher tax bracket. Another consequence of higher income from the RMD’s is the effect it will have on Social Security payments. Up to 85% of Social Security payments will be taxable if your income is above $44,000 for a couple and $32,000 for individuals in 2020.

2. Current tax brackets will sunset in 2026

When we turn the clocks over to the year 2026 the current Tax Cuts and Jobs Act that was passed back in 2017 will sunset and the rate for individuals and couples will revert back to where they were in 2016.  This means the tax brackets for will increase for all Americans.  With the amount of stimulus money that has been give to both individuals and companies it is difficult to image a world where our taxes will be lower than where they sit today.  From a planning perspective this gives us fives years for planning and finding ways to convert or contribute into Roth.

3. Passing money on to beneficiaries 

The SECURE Act that was passed by Congress back in December 2019 had a great deal of impact on retirement savings. One of the biggest changes this act made was on passing pretax IRA accounts onto the next generation.  The act eliminated the stretch provision over the lifetime of the beneficiary.  The benefactor of an Inherited IRA now must liquid the entire account within a 10 year period.  For example if a beneficiary receives a $1,000,000 inherited IRA they now have to take out at least $100,000/year to fully liquidated the account in 10 years. Think of your beneficiaries and the stages in life when they may receive these accounts.  Many of them could be in their highest earning years and this could be a very large tax burden at that time.  The solution to this is also a Roth IRA. Even though the beneficiary will still be required the liquidate the account in 10 years, the withdrawals they will be taking will be income tax free.

The solution for many can be to start converting or contributing to Roth savings both leading up to and in retirement. The advantage of a Roth IRA is that you do not have to take the Required Minimum Distributions.  Also, qualified withdrawals from a Roth IRA are received income tax free which can allow you to stay in a lower tax bracket in retirement.

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How much income is enough for your retirement? This is a common question I get when sitting down with clients. However, this can be a difficult question to answer because there is no one size fits all solution.  Determining how much income you will need is the first step to determining how much you need to save towards retirement. Please watch this video by Marlena Lee, PHD who is the Head of Investment Solutions at Dimensional funds. Marlena lays out a great framework to guide you through these decisions.  

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Here are 5 options of what you can do with your former employer 401(k) plan.  I will discuss the advantages and disadvantages of each option. For the purposes of this article I am going to assuming that the money in your account is traditional pretax money.  There are a couple differences with Roth 401(k) savings.  Keep in mind that every 401(k) plan has its own set of rules so when going over these options remember to double check what your plan does or does not allow.

1. Leave the money in your old employer’s 401(k) plan.  This option is available as long as the balance in your 401(k) plan is greater than $5,000.  This can be a good option for people that are in between jobs and are not sure where they will work next. The money in your plan will stay invested with the current allocations you have.  One of the advantages of the 401(k), if you are at a large company, due to the total amount of assets in the plan you may be paying lower fees than you would within an IRA. Also, if you retired or left your company between the age of 55 and 59.5 you are eligible for a withdrawal from the 401(k) without the 10% penalty. The disadvantage of leaving it in the plan is that the company is still the owner of the account and you are simply a participant in the plan. This means your former employer can change the investment options in the plan and change which company administers the plan.  While you are invested in the plan your only investment options are the mutual funds or company stock that is offered in the plan, and for some 401(k) plans these options may be very limited.  Also, another disadvantage I have seen is the withdrawal rules in your previous plan may be limited to full withdrawals only.

2. Roll the 401(k) to your new employer’s plan.  This is available if your new employer offers a 401(k) plan and the plan rules allow you to roll-in your previous employer plan.  One thing to consider will be the new investment choices that are offered in the plan. This is a good option if you plan to make contributions to your new plan and would like to have your retirement assets in the same account.  Another advantage is that if you need to take a loan from your 401(k) the amount rolled over can help to increase the amount that can be borrowed.  One of the disadvantages of this strategy would be if your new plan has a poor investment menu. Also, if you do not plan to work at your new employer for the long term you will be in the same predicament in the near term.

3. Rollover to an IRA account.  An IRA is an Individual Retirement Arrangement that is used for your retirement savings.  These accounts can be opened at nearly all financial institutions and have the same tax consequences as your 401(k) plan.  An IRA has several advantages over leaving it in your 401(k) plan.  Once you open the IRA you then become the account owner and can choose which financial institution you would like to have your account. Also, you can choose if you want to have this account professionally managed or if you want to direct the investments yourself.  Within an IRA you are not limited to the predetermined list of mutual funds to invest in.  An IRA allows you to invest in thousands of different mutual funds, ETF’s or individual stocks.  One thing to consider if you want to have your IRA professionally managed that may increase the fees you pay compared to your company 401(k) plan.  However, on the flip side, if you are a savvy investor many firms allow you to open an IRA for free and now offer commission free trades which can allow you to save money.  Two more advantages of an IRA are: flexibility of withdrawals, meaning any amount out at any time and lastly the ability to consolidate other old 401(k) plans into one account.

4. Convert to a Roth IRA. The fourth option you have with an old 401(k) is to convert the pretax money into a Roth IRA.  When converting an old 401(k) plan you will have to pay taxes on the total amount that is converted into the Roth IRA account. In order to pay those taxes the best way to do so is from an after tax account.  I would suggest not converting the entire balance all in the same year. In most cases it is better to roll to an IRA first and then convert portions of the account into a Roth IRA to spread out the tax liability over several years.

5. Cash out your 401(k). This is the last option and should only be used in emergencies.  Keep in mind that 401(k) plans are intended to be used for long term savings accounts and to replace your paycheck in retirement.  By cashing out you will lose out on the potential for compounded returns over the length of your career.  Right now the CARES act did waive the 10% penalty and you can also delay taxes for up to three years.  If you are considering this option I strongly suggest meeting with a financial advisor to consult with them before doing so.

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As we are all experiencing the wild swings in the stock market it is important to stay focused on your long-term goals and not get caught up in the day to day headlines.  This is the best time to revisit your financial plan.  Although the market at the close of business on Wednesday March 11 was down over 15% year to date did you know the 5 year rate of return is up over 30%? Another aspect to consider is what rate of return you need from your investments in order to achieve your financial goals.  When planning for your retirement it is important to use historical long-term rates of return. When using these benchmarks many people may come to realize that the returns, they have been experiencing are exceeding what is required for them to have a fully funded retirement.  These two weeks will have very little impact on your overall retirement.

What effect does a bull or bear market have on the likelihood that you will be able to retire the way you want?  What does this market volatility mean for your situation? The way to truly understand that is to look at the assumed rate of return you are using for your accounts in your financial plan.  Using sample client information the picture below shows how we can assume a rate of return for each one of your accounts. 

By using rates of return based on the historical averages of your investments we can see what the probability is that the money you have saved will last throughout your retirement.  We can also see what an up market, flat market and down market would do to the probability of your money lasting throughout your retirement.

Now is a great time to pull your plan back out and review it, ask questions about the rates of return you are assuming in the report, and remember to not panic over day to day swings in the market.

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