There are many different kinds of annuities.  We are only talking here about Single Premium Income Annuities [SPIA].  These are insurance contracts that guarantee a certain stream of income in exchange for a specific (usually one-time) premium.  A SPIA can be a very helpful and low cost retirement tool for the average person.  [Do not confuse these with variable annuities which are althogether different.]

The first thing to understand about a SPIA is that you are literally and figuratively “giving up” your cash.  You cannot change your mind later (after the usual ‘free look’ period, anyway).  The second important thing to understand is that the ‘guarantee’ is coming from the insurance company and only the insurance company.  Insurance companies are “rated” by different organizations, like “A.M. Best Company,” “Moody’s” and Standard & Poors”.  Picking a company with high ratings should therefore be your top priority.

Unless you are familiar with insurance contract provisions, it pays to have an agent (who will make a commission from the company selected) or a fee advisor (who will search for no-commission products).  This professional can can screen for all companies meeting your ratings criteria.  S/he can then review each company’s SPIA products in regards to payout amounts, payout options and contract provisions.

If you select an insurance agent, try to determine how truly “independent” they are.  Are they willing to ‘contract’ with new companies or do they have their own short list?  One way to find out is to ask for a list of companies that they have ‘access to’.  You also have a right to ask about the commissions being offered by the various companies that meet your criteria to help you determine if you are getting objective advice.

You will need to understand about payout options.  Here are a few examples:

• Single Life Only – the income stream will continue until your death.
• Joint with 100% to Survivor – the income stream will continue until the death of both you and your Survivor.
• Joint with 75% to Survivor – the full income stream will continue until your death, then 75% of the income stream will be paid to your Survivor until his/her death.
• Single with 10 years certain – the income stream will continue until your death HOWEVER if you die before you receive 10 years worth of payments, the balance of the 10 years worth of payments will be paid to a beneficiary that you designate.

There are many different combinations and permutations of the above.  Make sure that the payout option that you want is available on the specific contract that you select.

First, probability is no guarantee.  Let’s look at a 5% per year withdrawal rate.  In a 60/40 portfolio under typical market conditions, most number crunchers would agree that the portfolio should last thirty or more years.  Change market conditions to “extended poor markets” and you would likely be out of money before the twenty-four year mark.  If you had started withdrawing at age 62, you could be out of money before 86.  With one out of two seniors likely to live past age 90, this is not ideal.

Second, basing your retirement income on a magical number also misses the point of having a diversified investment portfolio – which is presumably to grow or accumulate money while maintaining the flexibility to respond to whatever life has in store for you.  Better to cover your ‘basic’ (i.e. bare minimum) living expenses another way and let your portfolio be the ‘gravy’.

Consider a retirement income strategy that optimizes a variety of retirement resources and strategies.  You will want to talk to your personal financial planner and tax advisor to see what might work best for you.  Here are a few ideas to consider:

• Keep enough money in bank or credit union accounts to cover emergencies and any large upcoming purchases.
• Cover your basic living expenses with guaranteed income streams like social security retirement benefits, pensions and the like.
• Replenish your bank accounts via withdrawals from your investment portfolio at the end of ‘good years’ and avoid withdrawals following ‘bad years’.
• Delay social security and spend down taxable investments instead.  (You will want to have your planner run the numbers on various social security claiming strategies first.)
• Keep tax-deferred investments deferred for as long as possible.  (This might not apply if you have considerable tax-deferred assets.)
• Rebalance your long-term portfolio at least once each year – forcing yourself to sell some of your winnings and buy things that are ‘behind’.
• Mix it up!  Diversify your long-term portfolio beyond the traditional asset classes and types.
• Commit a portion of your investments to high-quality dividend-paying investments and supplement your income with the dividends.
• Fully fund Roth accounts prior to retirement so that you may have the option of taking ‘tax-free’ withdrawals in the future. Make sure to learn all the rules that apply.
• Fully fund a Health Savings Account if you are in an eligible high-deductible health plan prior to retirement.  Contributions are deductible and grow tax-free.  Better yet, withdrawals for health expenses are tax-free after retirement.
• Understand NUA if you have employer stock in your employer plans.
• Never forget the impact of income taxes!  Tax-efficient investments and a tax-sensitive withdrawal strategy will stretch your resources even further.

Proper retirement planning should include the creation of a ‘mix of strategies’ that artfully weave your income needs together with risk and income tax reduction as well as estate planning and survivor needs.

“your best defense against ‘outliving your assets’?

Contest Rules:

1. Answers must be sent in using the CONTACT US form on this website. 
2. We will collect answers for exactly 48 hours from the time the question is posted. 
3. We will pick ONE WINNER at random from the correct answers received. 
4. The winner will receive two free MARCUS THEATER tickets, good for any movie at any time.

For the full list of rules go to: http://laurawilcox.info/blog/new-i-read-the-blog-contest/

People with provisional income above the thresholds must include some of their benefits as taxable income.  The most that needs to be included under current law is 85%.  How do you calculate the amount that must be included?  The best way to explain this is with an example:

Married Couple with Provisional Income of $50,000 and

combined Social Security Retirement Benefits of $30,000

           Calculation A (uses Provisional Income)

                0% of the first $32,000                                                                       =$          0

                50% of the amount between $32,000and $44,000                      = $  6,000

                85% of the amount over $44,000                                                    = $  5,100

                                                                                               Total              = $11,100

           Calculation B (uses Social Security Benefit)

                85% of entire benefit                                                                         = $25,500

The LESSER of A or B is $11,100 = the amount that must be included in taxable income.

In this example, only $11,100 of the $30,000 would be included in the couple’s taxable income.  We can use the same numbers but change the scenario to a Single Taxpayer with the following results:

Single Taxpayer with Provisional Income of $50,000 and

a Social Security Retirement Benefit of $30,000

           Calculation A (uses Provisional Income)

                0% of the first $25,000 is taxable                                                    =$          0

                50% of the amount between $25,000 and $34,000                     = $  4,500

                85% of the amount over $34,000                                                    = $13,600

                                                                                               Total              = $18,100

           Calculation B (uses Social Security Benefit)

                85% of entire benefit                                                                         = $25,500

The LESSER of A or B is $18,100 = the amount that must be included in taxable income.

In this example, only $18,100 of the $30,000 would be included in the individual’s taxable income.

The recipe for Provisional Income:

All income that would normally appear on page 1 of your federal tax return (except social security benefits)

+

Any amounts excluded from your income under an Employer Adoption Assistance Program

+

Anything deducted as interest on an education loan or as a qualified tuition expense

+

Anything earned in a foreign country, a U.S. possession or Puerto Rico

+

One-half of your Social Security Retirement Benefits

+

All tax-exempt interest

Summary

The good news is that all of the tax programs on the market today do these calculations for you!  Reducing provisional income can double your savings in some situations.  Because this is a complex topic, be sure to discuss your specific situation with your financial planner and your tax advisor.  They may be able to find some tax-saving opportunities for you.

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It is helpful, however, to first understand the ramifications of working while claiming benefits.  Keep in mind that, for each of the following, “earnings” refers only to money earned from employment.

Some Benefits May Be Withheld

Before Full Retirement Age [FRA] (look up here), your employment earnings will likely cause some of your benefits to be “withheld”.  Notice that the word is “withheld” and not “lost”.  It is a common misconception that these withholdings are a penalty of some sort and are lost forever.  That is not true.  Your retirement benefits are recalculated after full retirement age, taking into account:

• new amounts contributed,
• any amounts withheld due to employment, and
• whether your ongoing employment has increased your ‘average earnings’ (an average of your highest 35 years of earnings).

Higher average earnings, additional contributions and even withheld benefits all serve to increase future benefits.

The Earnings Test

To see how much may be withheld in the years before you reach Full Retirement Age, you can use the online Retirement Earnings Test Calculator or the following formulae:

Don’t Be Surprised if Benefits Suddenly Stop!

There is a lag of time between receiving a paycheck, the reporting of your earnings to the Social Security Administration, and the Earnings Test Calculations.  You may find that your benefit unexpectedly stops!  That is because a benefit withholding amount for a previous period has been calculated and is now being applied until fully repaid.  If you wish, you can call the Social Security Administration at 1-800-772-1213 and ask that the withholding be spread pro-rata over a number of months.

Receiving deferred sick pay, vacation pay, severance checks and the like after retirement often MISTAKENLY triggers the above scenario.  If this is the case, notify the Social Security Administration that ‘these amounts were earned prior to applying for Social Security Retirement Benefits,’ and this situation will be corrected.

Permanent Benefit Reductions

If you elect to take benefits early (i.e. before your FRA), your benefits will be actuarially reduced and this reduction is permanent.  It has nothing to do with working or withheld benefits due to an earnings test.  Taking benefits early can work out in your favor if you die before the ‘breakeven age’ – but against you if you live longer.  Your financial planner can run these numbers for you.

The information being provided is strictly as a courtesy. We make no representation as to the completeness or accuracy of information provided at third party web sites and are not to be held liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, sites, information and programs made available through this site. Cambridge does not provide tax or legal advice.

Who should use the easy answer?

• A single person who has never been married as long as that person is not expected to die prematurely
• The only income earner for a married couple as long as that person is not expected to die prematurely
• The highest income earner for a married couple as long as that person is not expected to die prematurely

Those who have a choice amongst two or more “types” of benefits will generally want to take the ‘largest’ benefit as late as possible.  Wait, you say!  A choice among “types” of benefits?  Who gets more than one choice?

• Anyone currently married (where both spouses qualify for benefits based on their own earnings records) has a choice between taking a ‘spousal benefit’ based on their spouse’s earnings record or a ‘retirement benefit’ based on their own benefit – or one first and then the other.
• Anyone divorced who was married at least ten years and has not remarried (where both ex-spouses qualify for benefits based on their own earnings) has a choice of his/her own retirement benefit, a spousal benefit – or one first and then the other.
• Anyone widowed after at least one year of marriage (with some exceptions) and not remarried before the age of 60 where both the deceased and the survivor qualify for benefits based on their own earnings records has a choice between a survivor benefit, his/her own retirement benefit, or multiple combinations of the two depending on age and situation.
• A widow remarried after the age of 60 will likely have the added choice of taking a spousal benefit based on the new spouse’s earnings record besides the usual survivor benefit and his/her own retirement benefit – or a combination of two or more of these.
• Of course, anyone widowed or divorced multiple times may have many earnings records to choose from.  I do not suggest proactively collecting ex- or deceased spouses for the purpose of increasing your options.

Certain tricks apply across the board, such as not being able to claim a ‘spousal benefit’ without automatically triggering a claim for your ‘own retirement benefit’ before your Full Retirement Age – or the fact that spousal benefits due not accrue delayed credits after Full Retirement Age while your own retirement benefit (or the benefit for your survivor) does.

Although this overview is an oversimplifcation, it should serve to give you the general idea behind what is now being called ‘Social Security Claiming Strategies’.  The representatives at your local Social Security Administration office may or may not tell you about all of your options so be sure to talk to your financial planner.  Customized projections can clarify the numbers – and help you to optimize these important benefits.  A financial planner can also take into account your other retirement income sources and help you find the most tax-efficient way to use them together.

* * * * *

The information being provided is strictly as a courtesy. We make no representation as to the completeness or accuracy of information provided at third party web sites and are not liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, sites, information and programs made available through this site or through the links included herein.