Archives for November 3, 2019

For many Americans, taking Social Security benefits at 62 is less of a choice and more of a necessity. A huge fraction of Social Security participants rely on the program for the majority of their income, and for some, their Social Security check is just about the only income they can count on month in and month out.

However, those who’ve managed to save up a healthy nest egg for retirement have more options. For them, delaying Social Security can be attractive, as it allows them to get larger monthly benefits later on, and in some cases pass those higher checks on to their loved ones in the form of survivor benefits. Yet there’s a choice that very few Social Security experts talk about — taking Social Security at 62 even if you don’t really need it, and investing your monthly benefits to generate additional returns.

The flaw in most Social Security analysis

Traditionally, most people looking at Social Security concentrate on the total amount of money they’re likely to get over the course of their lifetime. That’s in part because Social Security itself has argued that its benefit formula is designed to pay out roughly the same regardless of when you claim benefits — assuming that you live to roughly your actuarial life expectancy.

This approach has spawned breakeven analysis, which looks more closely at the impact of when you claim benefits. In general, if you just look at total dollars paid after adjusting for inflation, traditional breakeven analysis concludes that living through your late 70s or early 80s is the typical time at which delaying benefits starts to pay off. Here’s an example, based on someone who had earned a typical benefit of $1,400 per month at full retirement age of 66 1/2:

You can see that the lines start to cross each other somewhere between 79 and 82.

But the problem with traditional breakeven analysis is that it doesn’t reflect the time value of money. That might not matter so much for the many retirees who need to spend their Social Security as soon as they get it. For those who can invest their benefit checks, however, the time value of money makes a huge difference, because investing early benefit checks provides a longer time horizon for investment growth.

What a difference a positive return makes

Even modest return assumptions can make a marked difference in your analysis of when to claim Social Security. Say, for instance, that you were ultraconservative and wanted to put your money in bank CDs. Right now, you could get long-term CDs paying around 2% in annual interest. If you do that, here’s what happens to the graph above:

As you can see, the breakeven dates move out a little bit, with the earliest coming at around age 81 and the latest coming around 84.

Put in more ambitious return goals, and things get even more exciting. Here’s the graph for a 7% annual return:

The lines start to converge, but even at age 100, they haven’t yet touched. Claiming early gives you a sustained lead, and claiming later never catches up.

Some caveats to consider

The graphs above might convince you that claiming early is always the way to go. But there are many more factors to take into account, including these:

• The graphs above make the unrealistic assumption that returns will be smooth and consistent. In the real world, markets are often volatile, and an ill-timed bear market can make this analysis look a lot different.
• Taxation of Social Security benefits and forfeiture due to working before reaching full retirement age can reduce what you actually receive if you claim early, bringing that line in the graph down.
• If a spouse or children will collect survivor benefits on your work record after your death, then the overall impact can be different.

Yet for those who do have the financial resources to invest their Social Security, considering the time value of money is a worthwhile exercise. You might not end up changing your claiming decision because of it. But in some cases, it can make a big different in your overall financial well-being in retirement.

As you choose your benefits for 2020, don’t overlook a key saving account that could beat your 401(k) plan — at least in terms of taxes.

This year, nearly 3 in 10 employers that offer workplace benefits provided a high-deductible health insurance plan along with a tax-advantaged savings account, according to data from the Kaiser Family Foundation.

These health savings accounts come with three main tax benefits: You can contribute to them on a pretax or tax-deductible basis, and your savings grow free of taxes over time. You can also make tax-free withdrawals to cover qualified medical expenses.

There’s a fourth less well-known tax advantage: Contributions you make to your HSA on a pretax basis avoid Social Security and Medicare taxes, often known as FICA (Federal Insurance Contributions Act) taxes.

The same applies to contributions your employer makes to your HSA.

This FICA tax is 15.3% that you share with your employer.

The point is so compelling, it can spur companies to make even larger employer contributions to workers’ HSA accounts, said Aaron Pottichen, senior vice president of Alliant Retirement Consulting in Austin, Texas.

Indeed, in 2018, workers in high-deductible plans with HSAs received an average annual employer contribution of $603 for single coverage and $1,073 for family coverage, according to the Kaiser foundation.

In 2020, you’ll be able to contribute up to $3,550 to your HSA if you have self-only insurance coverage. This amount goes up to $7,100 for family plans

“The communication that we have is that every dollar you spend on your employees goes further because Uncle Sam isn’t digging his hand into it,” Pottichen said.

Know your savings

Consider a married employee who is in the 24% federal income tax bracket and is setting aside $7,000 annually on a pretax basis into his HSA.

This person would save more than $535 annually in Social Security and Medicare taxes alone each year, according to Pete Isberg, vice president of government relations at ADP, a payroll company.

Further, those contributions aren’t subject to federal income taxes, resulting in another $1,680 in annual savings, according to Isberg’s calculations.

This participant would save even more if he or she resides in a state that doesn’t subject HSA contributions to income tax.

See below for Isberg’s example.

Tax savings of an HSA under a ‘cafeteria plan’

• Contribution: $7,000
• Federal Income tax (24% bracket): $1,680
• Social Security (6.2%): $434
• Medicare (1.45%) $101.50
• State Income tax (assume 6%) $420
• Total savings: $2,635.50

If that same participant invested the money that would have otherwise gone to taxes, and it grew at a 3% interest rate, his family would save $30,200 over 10 years, Isberg said.

Remember, companies split the cost of the FICA tax with their workers, so employers’ contributions to HSAs also avoid this levy.

“Employers like health savings accounts because they also save on Social Security and Medicare taxes,” Isberg said.

“In this example, an employer with 100 employees all taking advantage of an HSA under a cafeteria plan may save over $53,500 annually, that would otherwise simply be a tax expense,” he said.

Understand the advantages

The contributions you make to a traditional 401(k) plan aren’t subject to the same tax treatment as your HSA savings.

While 401(k) plan contributions avoid federal income taxes, they still face the FICA tax. When you withdraw money from this retirement account, the distribution is subject to income taxes, plus a 10% penalty if you’re under 59½.

Meanwhile, distributions from an HSA are tax-free if they’re for qualified medical expenses. But if you pull the money out for other reasons, you’ll pay income taxes and a 20% penalty that’s in effect until you’re 65.

“If you know you’re using the money for those medical expenses, the HSA is much more attractive than putting the money in the 401(k),” said Eric Bronnenkant, a CPA and head of tax at Betterment.

You don’t have to choose one account over the other.

Here’s how you can fund both your 401(k) and HSA, according to Debbie Freeman, a CPA and director of financial planning at Peak Financial Advisors in Denver.

• Save enough to get the 401(k) employer match: This is free money. The most common match formula employers use is 50 cents on each dollar on the first 6% of pay, according to Vanguard.
• Put away sufficient money in your HSA to hit your deductible: Cash left unused in your HSA rolls over into the future. “In the years you have excess funds or you didn’t have to touch the account, start investing the money,” Freeman said.
• Optimize extra dollars: Max out your HSA and invest it for the long term. Stash any remaining dollars into your retirement plan.

“You know your contributions are going in and being immediately invested,” Freeman said.

If you are making $50,000 a year, planning to save $2 million for retirement can seem like an impossible goal. Yet, with some hard work, dedication and a lot of time, you can get there, regardless of your age.

As a rule of thumb, most financial advisors suggest you save 10% to 15% of your salary. But if your goal is to get to $2 million, the percentage you need to invest will vary widely based on how old you are when you start.

NerdWallet crunched the numbers, and we can tell you exactly how much of your $50,000 you’ll need to tuck away to get there.

Just a few things to remember: These numbers assume you have no money in your retirement plan, that you will get a 6% return on your investments and that you will retire at age 65.

The math also does not account for potential pay increases, employer matches, inflation or any curveballs that life may throw at you. So plan accordingly.

Now let’s dive into the figures.

There’s plenty of financial advice available on the Internet and in books, so it can sometimes be hard to decide which tips to follow.

But sometimes, you’ll read a quote or stumble upon some wisdom that can make you change the way you think about how you handle your financial life. These quotes could be profound or funny, but they stand apart because they lead to a change in perspective.

While these types of quotes may be few and far between, here are five of them that might just change the way you think about money.

Don’t tell me where your priorities are. Show me where you spend your money and I’ll tell you what they are — James W. Frick

Far too many people make budgets they don’t stick to, or claim they want to save for important goals such as retirement but end up spending their entire paychecks without putting a dollar in the bank.

This quote shows the importance of aligning your behavior to what you truly value. If you really care about retiring early or being debt-free, you’ll make the sacrifices necessary to do so. If you instead spend on frivolous things, you’re just showing that your pleasures today are more important than your security tomorrow. 

Wealth consists not in having great possessions, but in having few wants — Epictetus

If you’re constantly trying to keep up with the Joneses, you’re never going to feel you have enough. That’s why you’ll often hear stories of families with incomes in the mid-six-figures who claim to be barely getting by. 

This quote shows the importance of finding joy in the simple things. If you can be happy without the fancy car or the big house, you’ll feel a lot wealthier than someone with a higher income but with greater demands. 

Opportunity is missed by most people because it is dressed in overalls and looks like work — Thomas Edison

Managing money successfully is hard work — it involves sacrifice, saving when you want to spend, and sometimes working more than you’d like to have the money to accomplish all your goals. 

This quote underscores the importance of taking the hard road to financial success, rather than looking for get-rich-quick opportunities or lamenting the fact you’ll never be wealthy because you didn’t make that investment that would have made you rich overnight.

If you work hard and make the right financial decisions throughout your life, you will have the opportunity to build that big nest egg — but you need to seize the chances you have rather than waiting for an easy solution to financial woes. 

A bank is a place that will lend you money if you can prove that you don’t need it — Bob Hope

While this quote is humorous, there’s an important underlying truth to it. It demonstrates how opportunities to build wealth tend to collect around those who already have achieved some measure of financial success.

If you are a responsible borrower and work to build credit, for example, you can qualify for a mortgage or a student loan so you can build your net worth by acquiring an asset or increasing your income. Likewise, if you work hard to invest, you can grow your net worth by buying assets that increase in value. 

If all the economists were laid end to end, they’d never reach a conclusion — George Bernard Shaw

The key lesson within this clever quote: You can’t predict the future, and you shouldn’t try. Economists know this, which is why their advice is often equivocal — and it’s a truism you’re going to have to accept when managing your own money.

Instead of waiting for perfect investments or surefire wins, devise a strategy for investing that you can stick to over time even through unpredictable economic booms and busts. 

Do these quotes change your thinking?

Hopefully some of these quotes have changed your perspective on how you think about your finances. If not, there’s lots of other wisdom out there that might inspire you to look at money in a smarter way so you can use it responsibly to grow your wealth and establish a secure financial future.