WealthManagement Magazine

Social Stupidity

For most retiring clients and their advisors, Social Security checks are an afterthought in the planning process. After all, the benefits only make up about 40 percent of income for all seniors, and can be as little as 20 percent for the wealthier retirees whom advisors most desire as clients. But consider a couple, a man and woman in their mid-60s, receiving a total of $2,500 in monthly checks. The

For most retiring clients and their advisors, Social Security checks are an afterthought in the planning process. After all, the benefits only make up about 40 percent of income for all seniors, and can be as little as 20 percent for the wealthier retirees whom advisors most desire as clients.

But consider a couple, a man and woman in their mid-60s, receiving a total of $2,500 in monthly checks. The net present-day value of that income stream could be worth well over $350,000, depending on the discount rate and their life spans. Ignoring a portfolio portion that size could mean less money for your clients to live on — and for you to manage. Here are some common mistakes retirees make with their monthly checks, along with methods you can use to protect them from themselves.

One

They don't see how Social Security fits into the asset-allocation pie.

Financial advisors usually include Social Security checks in a client's retirement cash-flow projections, but rarely include the income stream in the portfolio makeup analysis. Say the hypothetical couple above also has $500,000 split evenly between fixed income and stocks. Adding in the present value of their benefit checks to the “bond” side tilts their portfolio to a 70/30 bond/stock mix. This blend may win the “preservation of principal” battle, yet lose the “purchasing power” war.

Solution: A $30 calculator can easily help you estimate the current value of clients' Social Security checks. And when you point out to them that this income stream is the safest immediate annuity on the planet (not to mention one with a built-in — albeit meager — cost-of-living escalator), you will find it easier to develop a stock-heavy asset mix that is more likely to generate income that will rise with expenses in the coming decades.

Two

They accept Social Security too early.

Listening to the media and political hullabaloo surrounding the Social Security “crisis,” and confronting the absence of a full-time salary for the first time in four decades, it's no wonder prospective retirees would rather take the bird in the hand during their early 60s, instead of two at the normal retirement age. The problem is compounded by the phenomenon that most rational clients have a pessimistic view of their respective life expectancy and don't feel they can beat the system by waiting until normal retirement age for the checks to kick in.

Solution: First, ask clients how old their parents are, or at what age they passed away. Politely point out that the clients are likely to live at least as long, especially with advances in medical technology. How long do clients have to live to “break even” on waiting until the normal retirement age to take their checks? It depends, but a rule of thumb is late 70s if the checks are being spent, early 80s if the money is being reinvested at a 4 percent annual return rate.

Three

They take Social Security while they're working.

Whether out of desire or necessity, 70 percent of people in the 50-to-70 age bracket plan on earning money after they leave their jobs, according to a recent AARP survey. But for early retirees, simultaneously collecting a paycheck and a Social Security check might put the “moron” in the working-after-retirement oxymoron.

A semiretired 62-year-old consultant working 40 hours a month at $50 per hour would earn about $24,000 per year. But if he also collects $18,000 from Social Security, his earnings will cost him about $6,000 in forfeited benefits.

Solution: A wise advisor would point out to the consultant that the client could work half as much and still receive $30,000 in pretax income and benefits, versus $36,000 under the current penalized arrangement. The semiretiree should either work only until he hits the $12,000 annual limit, or delay taking Social Security until he passes 65.

Four

They pay taxes on the Social Security payments.

According to the Congressional Research Service, in 2002 almost 40 percent of Social Security beneficiaries had payments that were subject to taxation. Nearly 11 million people receiving almost $95 billion in benefits were affected. And the problem is only likely to get worse. While almost all income tax floors and ceilings are adjusted upward for inflation, the income triggers for taxation of Social Security were set in 1983, and haven't budged since. Inflation has nearly doubled consumer prices since that time.

Owners of big IRAs are especially susceptible, as just taking the required minimum distribution on a million-dollar retirement account can easily send their government checks into the “taxable” category. And perhaps most outrageous is the rule that while interest on tax-free municipal bonds is indeed free from income tax, every coupon clipped counts toward making Social Security payments taxable.

Solution: Clients should get their financial house in order before they begin taking Social Security payments. First, if possible, IRAs should be converted to Roth IRAs, as future withdrawals from the Roth are not included in the “are my benefits taxable?” formula. Plus, the lack of a required minimum distribution will give clients more flexibility as to when and how much they withdraw.

Second, benefit collectors who buy tax-free bonds should reconsider their choice in debt instruments. Unless clients are in or above the 25 percent tax bracket and can get tax-free yields that are at least 80 percent of what a similar taxable bond pays, they may be better off sticking with a taxable option.

Getting help

Despite the fact that Americans receive a half-trillion dollars in Social Security checks each year, there are precious few resources reps can use to bone up on the Byzantine benefit process. The best place to start is the government's helpful Web site at ssa.gov, as well as Publication 915 at irs.gov.

Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future. kevinmckinley.com

SAD STATE OF AFFAIRS

It's bad enough that the Feds go after clients' retirement benefits, but some states may want a taste, too. Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, West Virginia, Washington and Wisconsin all can tax their residents' Social Security payments. Perhaps these states are concerned that not enough of their retirees were relocating to warmer climates…

GIMME BACK MY DUCATS

Important pieces of trivia for any advisor bent on maximizing his clients' take from the Social Security system.

  1. Retire early! And get a lot less money, forever

    Benefits taken at 62 will be about 20 percent less than if the clients were to wait until “full retirement age”…

  2. …Which isn't 65 anymore — at least not if your clients were born after 1937

    Full benefit age rises two months for every year after 1937 that your clients were born, until those hatched in 1960 and beyond have to wait until they turn 67 to collect full benefits.

  3. The first boomer will get hit right about…now!

    The government penalizes workers between the ages of 62 and 65 who apply for benefits while still collecting a paycheck. For 2005 their Social Security checks will be reduced by $1 for every $2 they earn over $12,000.

  4. Shock and amaze your clients

    By telling them that their Social Security benefits may be taxed. The formula goes a little something like this:

    a. Take half the amount of Social Security benefits

    b. Add in adjusted gross income

    c. Include tax-free interest!

If the total is between $32,000 and $44,000 for couples ($25,000 to $35,000 for singles), 50 percent of the Social Security payments will be taxed. If the amounts are over $44,000 for couples ($35,000 for singles), 85 percent of the payments will be taxed.

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