Retirement Planning and Employee Benefits for Financial Planners

Retirement Planning and Employee Benefits for Financial Planners Chapter 11: Social Security

Benefits Available • Retirement Benefits • Disability Benefits • Family Benefits • Survivors’ Benefits • Medicare • Supplemental Social Security

Social Security • Inadequate funding of Social Security • Ratio of workers to beneficiaries • 1950 16:1; 1960: 5.1 to 1; 2004:3.3 to 1, 2025:2.3 to 1 • Currently 55 million getting $1,077 average monthly check • Retirement life expectancy • 1935: 65 to receive benefits; life expectancy 62 years • 2008: benefits as early as 62, life expectancy 80+ • Number of workers • Where’s the money? • Used to pay current benefits • Excess invested in $1.5 trillion in Treasury bonds • Surplus projected until 2017

Social Security

Social Security • Inadequate funding of Social Security • 2010 report of trustees • Social Security will exhaust funds in 2037 • Will only be able to pay 75% of benefits • Solutions • Increase taxes by 2.15% • Tax all wages • Immediately reduce benefits 14% • Make $5.3 trillion contribution to trust fund • Keep COLA at inflation – 1% (eliminates 75% of shortfall) • Raise retirement age to 70 (eliminates 33% of shortfall)

Social Security • Inadequate funding of Medicare • 2010 report of trustees • Medicare will exhaust funds in 2029 • Solutions • Increase taxes by 1% • Immediately reduce benefits 17%

Social Security Taxes and Contributions • Federal Insurance Contributions Act (FICA) • Collected through payroll taxes • Total taxes of 7.65% • 6.2% up to $110,100 of compensation (OASDI) • 4.2% in 2012 • 1.45% of total compensation (HI) • An additional .9% HI for compensation above $250,000 MFJ beginning in 2013 • Unearned income above $250,000 MFJ is subject to a 3.8% HI tax beginning in 2013

Qualifying for Social Security Benefits • Fully Insured • 40 quarters of coverage • A quarter of coverage = $1,120 for 2012 of earnings • Maximum accrual of 4 quarters per year • Currently Insured • 6 quarters of coverage out of the previous 13 quarters

Qualifying for Social Security Benefits • Not covered by Social Security • Family employees • Child under 18 • Not in trade or business • Railroad employees • Ministers

Social Security Beneficiaries • Participant Worker • Participant’s Spouse • Participant’s Children • Dependent Parents • Workers Divorced Spouse (10+ Year Married)

Social Security Retirement Benefits • Retirement benefit payable at retirement • Fully Insured Retirees • Normal Retirement Age is increasing • Currently 66 years. Will increase to age 67 in 2027 • Increased benefit for delayed retirement • Retirement BEYOND normal retirement age • Decreased benefit for early retirement • Retirement BEFORE normal retirement age • Monthly benefits increase each year based on COLA

Calculating the Retirement Benefit (1 of 3) • Calculate the worker’s Average Indexed Monthly Earnings (AIME) • Convert earnings after age 21 to current dollars using an indexing factor. • Earlier earnings, higher factor • Sum the highest 35 years • Divide sum by 420 months

Calculating the Retirement Benefit (2 of 3) • Calculate the worker’s Primary Insurance Amount (PIA) • Sum of three separate percentages of the AIME • 90% of the first $767 (2012) • 32% of the AIME over $767 and less than $4,624 (2012) • 15% of the AIME that exceeds $4,624 (2012) • Consequently, workers with lower income will receive a much higher percentage of their wages in social security benefits • Low income workers: social security 60% of retirement income

Calculating the Retirement Benefit (3 of 3) • Worker would receive PIA. • Maximum PIA = $2,461(2012) • A beneficiary of the worker may receive a percentage of the PIA: • Spouse w/child under 16: 50% • Spouse, age 65: 50% • Spouse can receive benefits based on her PIA if it is greater • Spouse, under age 60: none • Child under 18, 50%

Calculating the Retirement Benefit (3 of 3) • Deceased worker • A beneficiary of the worker may receive a percentage of the PIA: • Spouse w/child under 16: 75% • In general, must be married nine months at time of death but exceptions to rule exist • Spouse, age 65: 100% • Spouse can receive benefits based on her PIA if it is greater • Spouse, over age 60,: 71.5% • Child under 18, 75%

Early Retirement • May begin at age 62. • Permanently reduced benefit: • Currently receive 75% of normal retirement benefits • But nearly 50% elect to retire at age 62 • Almost 70% elect to receive benefits before normal retirement age • By 2027, receive only 70% of normal retirement benefits • Journal of Financial Planning, Jan. 2004 • Breakeven generally occurs at age 73-74 • 70 – 80% likelihood of someone age 62 living to age 74

Delayed Retirement • Begin taking retirement distributions after normal retirement age. • Permanent increased benefit. • Increases the benefit by 8% for each year of delayed retirement from normal retirement (age 65, 10 months) until age 70. • Consequently, benefits increased by 32% if wait until age 70 to begin collecting benefits • Consequently, often recommended strategy • Higher income spouse delay until age 70 • Increase his suspended benefits, but spouse can draw 100% normal retirement benefits • Lower income spouse take at age 62 • Switch to spousal benefits at death of spouse

Retirement Earnings Limitations Test (1 of 2) • Social Security Retirement benefits are reduced for early-retirees who have earnings from continued employment. • Earnings • Wages • Self-Employment Income • NOT Earnings • Pension Income • Investment Income • Capital Gains

Retirement Earnings Limitations Test (2 of 2) • Before normal retirement age and collecting Social Security: • $1 reduction for every $2 of earnings above $14,640 for2012 if don’t reach full retirement age in 2012 • $1 reduction for every $2 of earnings above $38,880 for2012 if do reach full retirement age in 2012 • Don’t take Social Security early if plan to continue to work • After attaining normal retirement age, $0 reduction.

Taxation of Social Security Benefits (1 of 3) • Retirees with substantial income in addition to Social Security benefits. • Up to 85% of the Social Security benefits may be taxable • Modified AGI (MAGI) • AGI + Nontaxable Interest + Foreign Earned Income

Taxation of Social Security Benefits (2 of 3) • Second Hurdle > MAGI + ½ of Social Security Benefits > First Hurdle, the taxable amount of the Social Security Retirement benefits is the lesser of: • 50% of Social Security Benefits, or • 50% [MAGI + 0.50 (Social Security Benefits) less Hurdle 1 Value]

Taxation of Social Security Benefits (3 of 3) • MAGI + ½ of Social Security Benefits > Second Hurdle, the taxable amount of the Social Security benefits is the lesser of: • 85% of Social Security Benefits, or • 85% [MAGI + 0.5(Social Security Benefits) less Hurdle 2], plus the lesser of: • $6,000 for MFJ, or $4,500 for all other taxpayers, or • The taxable amount calculated based on the 50% formula and only considering Hurdle 1

Disability Benefits • Benefits payable to workers with: • Severe physical or mental impairments which prevents them from performing “substantial work.” • Cannot perform any gainful work. • Payable at any age. • Fully insured with 20 quarters of coverage in the last 40 quarters.

Family Benefits • Benefit payable to family members of worker receiving retirement benefits or disability benefits. • Spouse • 62 and older • Caring for a child under age 16 • Caring for a child who was disabled before age 22 • Unmarried Child • Under 18 • Under age 19 and in high school • Age 18 or older and disabled before age 22

Survivors Benefits • Benefits payable to family members of deceased individuals who were entitled to benefits. • Widow or Widower • 60 and older • Over 50 and disabled • Caring for a child under age 16 • Caring for a child who was disabled before age 22 • Unmarried Child • Under 18 • Under age 19 and in high school • Age 18 or older and disabled before age 22 • Dependent parents of the deceased worker

Death Benefit • One-time $255 death benefit payment • Paid to deceased worker’s surviving spouse, or minor child (if no spouse).

Maximum Family Benefit • Limit on the amount of monthly Social Security benefits paid to the family of a deceased worker. • Based on the deceased worker’s PIA.

Medicare Benefits • Federal health plan for: • People 65 and older • Disabled individuals • Individuals with permanent kidney failure • Consists of: • Hospital Insurance - Medicare Part A • Medical Insurance - Medicare Part B • Prescription Drug – Medicare Part D

Medicare

Hospital Insurance – Medicare Part A • Covers • Hospital Coverage, and • Skilled Nursing Care • Deductible for inpatient hospital care: • $1,156 deductible per illness for 2012 • for the first 60 days • $289 for 2012 per day for days 61-90, and • $578 for 2012 per day for days in excess of 90. • Skilled nursing care deductible $145 for 2012 per day for 21st day to 100th day. • Coinsurance based on benefit period

Medical Insurance – Medicare Part B • Individuals pay monthly premium. • Increases based on AGI • $100/mo if AGI < $170,000; $320/mo if AGI > $428,000 • Covers 80% of: • Doctor’s Services • Ambulance Transportation • Diagnostic Tests • Outpatient Therapy Services • Outpatient Hospital Services • Medical Equipment and Supplies • $140 annual deductible in 2012.

Prescription Drug – Medicare Part D • Began January 1, 2006. • Insurance coverage for prescription drugs. • Participant must enroll and pay a monthly premium and a portion of each prescription.

Supplemental Security Income • Monthly payments to individuals with low income and few assets: • 65 and older • Disabled • Blind • Single: $698 per month for 2012. • Married: $1,048 per month for 2012.

Effect of Marriage or Divorce on Benefits • Worker receiving benefits based on his own earnings • Benefits continue regardless • Individual’s receiving benefits based on spouse’s earnings • Benefits cease at divorce, unless • Individual is 62 or older and was married longer than 10 years • Widows and Widower benefits • Benefits cease at remarriage unless 60 or older

Retirement Planning and Employee Benefits for Financial Planners