Front Street Wealth Management

Fee Only, Proactive Wealth Managment

Social Security New Rules – Part II

by

In this second segment of in my series on the new rule changes within Social Security, I will delve into other aspects worthy of deeper analysis.

Where my previous column highlighted the late April 2016 deadline faced by a 66 year-old couple planning on using Social Security’s “file-and-suspend/restricted application” trick to maximize their benefit, this week focuses on how the new law affects two younger demographic groups; those age 62 to age 65.5 and those younger than age 62.

Over the next four years, Congress is winnowing down the filing options that Social Security now offers. As time passes, the available choices for retirees will become fewer and fewer. The upside of this narrowing of choices is the beauty of simplicity for future retirees. The downside, as you might have guessed, is your Social Security benefits over your lifetime will likely be less than those received by the prior generation.

To begin, if you won’t reach age 62 by the end of this year, you will not be allowed to restrict your filing to just your spousal benefits. If you fall into this younger group, Social Security will simply pay you the greater of your own earned benefit or the benefit you’re entitled to receive as the spouse of another then-collecting worker.

With these simplified rules, for the youngest among you, Congress just took away your ability to begin collecting your spousal benefit – which can begin at age 66 – while also simultaneously deferring the benefit you may have earned yourself. That “restricted application” trick is over for you.

This ability to collect only your spousal benefits – and watch your own benefits based on your work record grow year after year after year – is now only available to those who are at least age 62 by the end of 2015.

For this slightly older group – let’s call them the middle demographic – you will still have the right to collect your spousal benefit at your full retirement age, to continue to let your own benefit grow 8% per year until age 70 and then, finally, to switch over to your bigger benefit. But, there’s a catch to remember with this strategy.

Unlike the older retirees profiled last week, for this middle demographic to be allowed to restrict their filing to only their spousal benefit, their spouse must also be collecting their own benefit.

With deadlines approaching and with the key role Social Security plays in retirement income planning, understanding the rules has gained importance.

Social Security New Rules – Part I

by

There is yet another financial planning deadline looming on the horizon. Congress was nice this time as this newest deadline occurs when the snow melts by April 30, 2016. Nonetheless, time seems to move at an accelerated pace and May will be here before you know it. For that very reason, planning around the latest rule changes regarding Social Security is something to act upon well before then.

To begin, Social Security presents complexities that are not fully recognized by most people. Many retirees consider Social Security a benefit that is simply started at a particular age. Most commonly, surprisingly, people apply at the earliest eligible age of 62. In fact, almost half file for benefits at the earliest moment possible and, as a result, accept a permanent 30% reduction in benefits for life.

On the other hand, some people plan extensively to maximize their Social Security benefits. The latest law changes – hot off the presses – significantly affect their well-laid plans. These people should bone up now on the changes as Congress has set a clock that’s ticking down.

For background, the most classic Social Security maximization strategy is one used by dual-income couples. The strategy goes something like this, assuming a same-age couple.

The higher earning spouse – let’s say it’s the husband, in this case – files for benefits at age 66 and then immediately suspends his Social Security benefit. This move is called, file-and-suspend. During his benefit suspension period, his eventual benefit will grow 8% larger for each year he waits to collect – until he hits age 70.

Now, because he formally filed for benefits, his wife is entitled to receive her spousal benefit equal to 50% of his benefit amount, even if he’s chosen to not collect his benefit. All spouses are entitled to receive this 50% benefit. In this example, she is not filing to receive the benefit she’s earned through her own lifetime of work. Instead, she’s only choosing to receive her likely smaller spousal benefit. This move is called, filing a restricted application.

The trick is, while she’s collecting her smaller spousal benefit, her own eventually larger benefit – the benefit that’s based on her work record – will continue to grow 8% per year, until she too reaches age 70. For dual-earning couples, this strategy works to maximize their Social Security benefits.

And, here’s the punchline, this strategy – for those who haven’t already put it in place – will end on April 30, 2016, unless they act by then.

Of course, the myriad of Social Security claiming strategies are nearly endless and deserve individualized analysis. In future columns, I will address additional situations affected by the recent law changes. Change is clearly a rule and Social Security’s new rules are no exception.

Jason P. Tank, CFA will hold a free public educational workshop on this topic on December 9th at 6:30pm at the Thirlby Room at the Traverse Area District Library.

No Holiday From Financial Tasks

by

As part of my series on end-of-year financial tasks, there are a few deadlines that many people need to pay attention to as they do annual planning with their investment advisors and other consultants.

I’ll highlight one in particular that is of extreme importance for many senior investors. I’ve discussed this in past columns, but it bears repeating given the onerous penalties you face if you do not comply with the law.

Once you reach age 70 1/2 and forevermore, you face what is referred to as a “required minimum distribution” from your IRA accounts. Like too many things, this one goes by an acronym of RMD. Essentially this is your annual requirement to withdraw a certain minimum dollar amount from all of your tax deferred accounts.

The logic behind this is the government wants to finally collect its take on the money you’ve put away and invested free of taxes. Their required minimum distribution rule assures the tax is paid.

If you don’t comply – whether or not your neglect is completely benign – the penalties are extraordinarily harsh. They can total 50% of the expected annual distribution. Please don’t forget. With penalties like these, a double-check is just a smart policy.

Typically, after your first required minimum distribution has been processed by your account custodian or brokerage firm, the subsequent distributions from your tax-deferred accounts will become automatic. This lessens the burden placed on you to remember each year.

However, your first distribution must be set up manually either with your advisors help or by you if you are a do-it-yourself investor. It’s often this first year where an oversight can occur.

While it should be simpler than this, there are a few nuances with required minimum distributions that are worth discussing further.

The first involves people who may have inherited an IRA from a non-spouse loved one. In this case, the required minimum distribution rule can be much more burdensome. With Inherited IRAs, the custodians or brokerage firms often do not set up an automatic process in subsequent years as they do for non-inherited IRA account holders. Therefore, Inherited IRAs require some extra care.

In my experience, the prospect of forgetting to take an annual distribution occurs with situations of Inherited IRAs. To minimize the risk, my advice is to speak to an advisor the moment you inherit an IRA.

In addition, in the year in which you turn 70 1/2, there are special rules regarding the required timing of the first annual distribution. To discuss the benefits of this special first-year rule, it may require a personalized conversation with your investment advisor and your tax consultant to help craft the most tax efficient strategy.

As is often the case in life, the busiest times of the year, such as the holidays, often inconveniently correspond with some of the most important times of the year to review your financial situation. There’s simply no way around it, no matter how much you and your advisers would love to have the ability to turn back time!

The Season for Financial Planning Strategies

by

It’s the season to do some year-end financial planning. If you haven’t spoken with your adviser in a while, this may be a great time to engage in a conversation about any changes in your financial life.

Throughout my career I’ve seen a number of opportunities lost due to a lack of coordination between clients’ many different advisers. Please don’t let this happen to you.

To prod you forward, I recommend you first review any major changes in your financial life during 2015. For example, did you incur unusually large medical expenses this year? Have you sold something that resulted in an extraordinary gain or loss? Has your income increased considerably? Or has it possibly decreased due to a job loss or job change? The list of possible changes in your life is vast.

With this information in hand, there are many opportunities to save money. Unfortunately, many are connected to a deadline of December 31 involving our overly-complex and often unforgiving tax code. It’s clearly too much for a normal, busy person to follow. Therefore, if you’ve engaged advisers for your investments, tax planning and legal affairs, encouraging a coordinated level of service can work wonders.

For example, do you know that federal capital gains are taxed at a 0% rate if your taxable income falls below the 15% federal tax bracket threshold? If you are sitting on unrealized capital gains from years worth of gains, you may be able to take advantage of super low capital gains taxes in a year in which you earn less than typical.

In addition, if you are able to show less taxable income this year than normal, it may be intelligent to consider a partial Roth IRA conversion from part of your regular tax-deferred retirement accounts. Of course, the analysis required for Roth conversions is not simple and does involve making a reasonable set of assumptions about the unknowable future. Doing that analysis is a smart move.

Another possible retirement savings strategy is available to self-employed individuals who have the desire to save more and pay less tax today. If you qualify, a high-earning small business person can save much more through a little-known vehicle called an Individual 401(k) than they can through a regular IRA. Unlike a regular 401(k) plan for a small business, these special use 401(k) plans are not complex or costly to set up or maintain.

However, if you don’t make the right moves with this information by December 31, you stand to miss out on these planning opportunities and more. As the famous Nike ad once said, just do it – before the busy holiday season. Amazingly, it’s once again just around the corner.

There’s Value in Warning Signs

by

The Chinese panicked, stock markets around the world choked and the Fed blinked. What a quarter it was, replete with swings only a die-hard baseball fan could enjoy.

After a 6% drop in broad US market indexes, is this just the beginning of a deeper decline or only a long-awaited, run-of-the-mill correction with continued gains ahead?

It’s true, some headline data describes an economy that is still growing. Following a weak first quarter affected by the cold, the government’s official guess for the second quarter showed nearly 4% growth. The unemployment rate is down to almost 5%. Inflation, excluding energy prices, is still well below the Fed’s arbitrary 2% target. And, with rates low, auto and home sales are doing just fine. All in all, the view from 30,000 feet looks fine enough.

Now, to the on-the-ground view. We all know financial markets don’t operate on how things appear today. Instead, they focus on that never-to-arrive and always-uncertain, tomorrow. Given this, I think markets are flashing yellow warning signs.

First, risks are rising in lower-rated corporate bonds. Lower-quality bonds have declined about 5% in short order. This is raising concern among investors as weakness in junk bonds has traditionally been a leading indicator for periods of weak stock markets.

Next, stock prices are way down for companies most sensitive to cyclical economic shifts, such as industrial companies, big-ticket equipment manufacturers, commodity- and basic material companies as well as transportation companies. Compared to the market as a whole, these sectors have felt a much bigger brunt of the recent market downdraft.

In the midst of this under-the-surface activity, what’s catching my eye?

To begin, despite the uncertainty in the oil and gas market, I feel strongly there is value to be found in the massive carnage. Choosing even among the blue chip companies, such as Exxon Mobil, investors can benefit from large dividends at today’s low prices.

Next, there are a number of financially-strong industrial companies, such as Dow Chemical, that actually benefit from low energy prices. At a 4% dividend yield today, Dow provides the type of income that helps to battle this inhospitable rate environment. In addition, companies in the midst of corporate transformations, like Alcoa, offer good prospects. I also see tremendous value in a much-improved General Motors that currently pays a dividend of almost 5%.

Lastly, many blue-chip tech companies are just flat-out bargains today, in my view. With huge cash piles and serious earnings power, I think companies like Apple, Cisco and Microsoft are too hard to ignore for long-term investors.

Now, if the current yellow warning signs turn into bright red stop signs, you should also fully expect to see bargains go lower still. That’s the way markets work, of course, so please be sure to diversify and use common sense.

I do believe a change is afoot in markets today. Navigating it is going to require skill and investors might just want to get re-acquainted with seeing some red figures in their quarterly statements. If managed properly, for the prepared investor, yellow and red are not colors to be ignored or to be feared.