Archives for February 26, 2020

It goes without saying that death and taxes are two of life’s certainties.

But what many people don’t know is that their Social Security retirement benefits might be taxed.

And that means that they haven’t been using strategies proactively to reduce those levies and extend their income over their retirement years.

William Meyer, founder of Social Security Solutions, a provider of benefits-claiming software, estimates that, on average, you can find up to seven years’ worth of more money by creating tax-efficient withdrawal strategies that coordinate Social Security benefits.

And those savings can be as much as hundreds of thousands of dollars, according to Meyer.

“It adds up to a lot of money for most people,” Meyer said. “It doesn’t matter if you have a lot of money or a little.

“That savings can be substantial.”

How Social Security benefits are taxed

Approximately 40% of people who receive Social Security benefits pay federal income taxes on that income, according to the Social Security Administration.

If your income is low enough, none of your Social Security income may be taxed. But there are two additional tax tiers, which means that either 50% or 85% of your benefits could be subject to federal tax.

In order to know where you fall, you need to know your “provisional,” or combined, income.

To calculate that, add your adjusted gross income plus non-taxable interest plus half of your Social Security benefits. Those values can be found on your 1040 tax form.

If you file as an individual, you are subject to taxes on up to 50% of your Social Security benefits if your combined income is between $25,000 and $34,000. But if you’re over $34,000 in combined income, up to 85% of your benefits are subject to income taxes.

If you’re married and filing jointly, those thresholds for combined income are higher. You will be subject to taxes on up to 50% of your benefits if your income is between $32,000 and $44,000. That goes up to up to 85% of your benefits if your income is more than $44,000.

And if you’re married and filing separately, you could also pay taxes to the tune of up to 85% of your Social Security income. That’s what Joe Elsasser, president and CEO of Covisum, a Social Security claiming software company, calls a “gotcha” for those taxpayers.

Many people find out whether they owe federal income taxes on their Social Security income at tax time when they tally their Social Security benefit statement and other income.

Of note, you may also face state taxes on your Social Security income, depending on where you live. Most states do not impose levies on these benefits. But 13 states do, though the rules for that vary from state to state. Those states are Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia.

Why you want to avoid a tax torpedo

If you’re just now adding up your income for your April returns, it’s too late to mitigate those Social Security taxes.

But it’s not too late to try to bring down the rate at which you will be taxed on your benefits income for the next tax year.

What you most want to watch out for is something called the “tax torpedo.”

A tax torpedo occurs when there is a sharp rise and fall in marginal tax rates due to the taxation of Social Security benefits. Marginal tax rates are the extra taxes you pay on each additional dollar of income.

For example, a hypothetical single retiree receiving $30,000 per year in Social Security benefits, in addition to other income, could have a marginal tax rate of 0% if their modified adjusted gross income is up to $12,400, according to research published by Meyer.

But that could climb to 15% for income between $12,400 and $18,750; 18% on $18,750 to $19,000; 22.2% on $19,000 to $34,568; and then up to 40.7% on income between $34,568 and $43,706. Beyond $43,706, the marginal tax rate could drop down to 22%.

Meanwhile, how much of their Social Security benefits are taxed also climbs with those thresholds, until 85% of the Social Security benefits are taxable at modified adjusted gross income of $43,706.

But there are strategies to prevent those tax rates from climbing so high. Waiting to claim Social Security benefits for as long as possible — up until age 70 — is one, according to Meyer. That’s because that could help to increase Social Security income while decreasing the amount of money you take from tax-deferred retirement accounts such as 401(k) plans.

The other strategy is to adjust the sources from which you take your income.

One area to watch is how withdrawing extra money from an individual retirement account can increase your tax bill.

If you’re at a 12% tax bracket and take an extra $1,000 out of your IRA, you could consequently lose almost $500 to federal income taxes due to an “ugly interaction” between Social Security, ordinary income and capital gains, Elsasser said. “That shocks a lot of people,” Elsasser said.

To mitigate that, it helps to be mindful about how your decisions could trigger higher taxes.

“What you’re really looking to do is change the blend of income that you have in order to actually save tax dollars rather than just prepay them,” Elsasser said.

To help keep capital gains down, you could opt to use more tax-efficient investments such as exchange-traded funds instead of mutual funds, Elsasser suggested. Investment-only variable annuities could let you defer taxes until you take withdrawals, he said. The risk is that that can, however, increase your ordinary income.

You may also look for losses to offset gains in a portfolio, Elsasser said.

You may also want to tap non-taxable accounts, such as a Roth 401(k) or Roth IRA, that will not count as ordinary income, Meyer said.

Even if you think you’re already at that highest 85% level for Social Security taxes, there are likely still strategic moves you can make, Meyer said.

“Be very strategic about your withdrawal strategy,” Meyer said. “You might be able to draw down in a sequence that keeps less of your Social Security taxed.”

For help, the best source to consult is a competent financial advisor who is able to offer advice on both retirement income and taxes, he said.

Everyone needs to save. In fact, you should be setting aside cash for retirement and other financial goals. Whether you want to buy a house, go on vacation without going into debt, or make some other big purchase, saving is the smartest way to do it.

Unfortunately, while most of us know this, we also have lots of excuses for why we don’t do it. The problem is, the longer you make excuses, the more compound interest you miss out on and the harder it becomes to save enough to accomplish anything important.

If you find yourself justifying why you’re not saving more of your money, check out these three common excuses below. If they’re the reasons you use, you’ll find some tips to help you get more money in the bank.

1. You don’t have enough money

Sometimes, your income really doesn’t stretch far enough to meet your essential needs and still let you save money. If so, the only option you’ll have is to increase the income available to you. You could do this by:

• Asking for a raise. Come prepared with evidence, such as proof of recent successes and market salary data, to show you deserve a higher salary. 
• Looking for a better job. If your company won’t pay what you’re worth or your job is a dead-end with little potential to increase your income, switching to a new position may be best.
• Working a side gig. There are ample opportunities to earn extra in the gig economy. Think about what you’re interested in and what your skills are in order to find a niche for yourself.
• Improving your skills. If you can’t justify a raise or find a side gig, you may need to take some courses or talk with your company about training programs you could take advantage of so you could earn a higher salary. 

2. You have too many expenses

For many people who claim to have too little money, the problem isn’t really one of income but rather excess expenses. If you’re spending too much of what you earn, you won’t be able to save any of it.

To determine if too much spending is your problem, track what you spend for about 30 days. Once you see where your money goes, look for cuts to make to discretionary expenses such as dining out or entertainment. 

If you find you’re overspending, living on a budget would enable you to save more. Set spending limits on different types of purchases and, once you hit those limits, stop spending. If you have difficulty keeping track, try an envelope-based budgeting system: Put the money you’ve allocated to each purchase category in an envelope and spend only the cash available. 

3. You don’t know how to get started

Figuring out how to save and invest doesn’t have to be complicated, although it can seem that way. The simplest way to start saving is to open a high-yield savings account and deposit money into it. This approach makes sense for an emergency fund or for money you’ll need soon, such as for a vacation you plan this year. 

For longer-term saving, especially for retirement saving accounts, you’ll want to invest with a broker so you can buy stocks. If you have a workplace 401(k), signing up to make contributions is usually easy — just request the paperwork from HR. If you don’t have a 401(k) or want to invest outside your workplace plan, you can open either a retirement account or standard brokerage account with an online broker. It takes just a few minutes and you can set up an automated transfer of funds so you get on a regular saving schedule. 

Once you’ve put your money into a brokerage account, you can buy low-fee exchange-traded funds (ETFs) that give you exposure to a broad range of different kinds of assets so you can easily diversify your portfolio even if you don’t know how to pick individual stocks. Our model portfolios can give you some ideas of what you can invest in. 

Overcoming these excuses is essential

While you can probably come up with lots of reasons not to save, none are good enough to justify not putting away some cash for the future. If you don’t save, accomplishing financial goals will be next to impossible and you’ll set yourself up for a hard time later. Now is the time to find a way to overcome the obstacles holding you back. 

As a general rule, the higher your credit score, the better off you are.

However, a missed payment or default can quickly drag your score down, sometimes significantly.

As many consumers know, your credit score plays a big role in daily life. It can determine the interest rate you’ll pay for credit cards, car loans and mortgages — or whether you’ll get a loan at all.

Those three digits can save you tens of thousands of dollars over time, or cost you just as much.

“Depending on your credit history, a 15- or 20-point shift could mean the difference between being approved or declined or better terms or higher costs,” said Rod Griffin, the director of public education at Experian, a major credit-reporting firm.

The good news is that average credit scores have steadily ticked higher since bottoming out during the housing crisis about a decade ago, when there was a sharp increase in foreclosures. Now scores are at an all-time high, according to FICO, a leading credit-scoring company. FICO scores range from 300 to 850.

The best way to increase your credit score comes down to paying your bills on time or reducing your credit-card balance.

Your payment history and utilization rate typically account for 60% to 70% of a credit score, according to Experian.

Such positive credit behaviors can start to improve your score as soon as a few billing cycles. “As a rule of thumb, you could see an appreciable difference in six months,” said Ted Rossman, an industry analyst at CreditCards.com.

However, that also depends on the issues you are trying to overcome. (See financial comparison site SuperMoney’s charts below based on data by VantageScore and FICO.)

For example, “if a missed payment has dragged your score down, your score could rebound in a month or two, a series of late payments will take longer to make a full recovery,” Griffin said.

Being late on a mortgage payment is a more serious problem, yet you can recover from that in as little as nine months. File for bankruptcy, on the other hand, and it could take 5 years to 10 years to get back to where you once were, according to Miron Lulic, the founder and CEO of SuperMoney.

In addition, the condition of your credit history also plays a role, Griffin added. “The better your scores are to start with, the more difficult it is to improve them.”

That’s because a lower credit score reflects a pattern of missed payments. Adding one more missed payment is not as significant as it would be on someone who has a clean credit report, according to Lulic.

The goal isn’t to have a perfect score, Griffin said. “The goal is the have a score that qualifies you for the best terms of rates, generally 750 or above.”

Regardless of your starting point, to achieve very good or excellent credit, there are simple things you can do that will have an immediate impact. Here are five tips from SuperMoney to give your score a boost:

1. Check your credit report and dispute every error you find.
2. Pay your bills on time. Late payments stay on your report for seven years.
3. Pay off your credit card balances. This will reduce your credit utilization ratio, which will do wonders for your score.
4. Stop applying for credit. Hard inquiries ding your credit for up to 12 months.
5. Ask a relative or friend who has good credit habits to add you as an authorized user on their credit card. As long as their payments are made on time, your credit score will improve.

By the time most of us reach retirement age, we feel as if we don’t have enough money to live the life we envisioned.

Our feelings aren’t wrong: a 2019 analysis from the Employee Benefit Research Institute found that over 40% of American households in which the official head is between their mid-30s and mid-60s are projected to run short of money in retirement.

The figures are especially concerning when it comes to millennials (or those currently between the ages of roughly 24 and 39). According to a 2018 report by the National Institute on Retirement Security, 67% have nothing saved for retirement at all.

But there’s a way to fix the problem. As a social psychologist who has been researching perception and motivation for 15 years, I’ve found that, when it comes to financial challenges, narrowing your focus can push you — mentally, at least — to the retirement finish line faster.

‘The future seems so far away’

A major reason for the big disconnect between what we will need and what we end up having is that so many of us start to prioritize retirement savings too late in life.

That’s a shame, because starting earlier, rather than making up for lost time later on, is generally a more lucrative rule of thumb. All else held constant, thanks to compound interest, a 22-year-old who sets aside $100 a month will enter retirement with a larger nest egg than someone who puts in five times as much each month, but starts saving 20 years later.

To get a better handle on why younger people set aside so little — if any — income for retirement, I took an informal poll of students I was teaching one semester. Even though they all had jobs, 55 out of 60 said no when asked if they were saving for retirement.

When asked how often they think about retirement, the popular answers were “not often” and “maybe once or twice a year.” The main reason can be summed up by one student’s response: “The future seems so far away.”

I wanted to see if I could change their perspective — by getting them to see their future retired self as closer and more relevant to the person they are now. Perhaps then the future itself would not seem so distant.

So I took photographs of their faces and, using computer imaging software, blended each face with that of an older celebrity. Then I made an animation for each student, depicting the transition from current self to future self.

After handing out their headshots, I asked each student to write down what they hope a typical day in retirement would entail, and how they’d like to spend their time at that point in their lives. Then I asked, “Would you start saving for retirement now?”

They all said yes.

Seeing your savings successor

My project was based on a real experiment conducted in 2011 by social psychologist Hal Hershfield, who found a way to introduce young people to their future selves.

Participants were divided into two groups. Hershfield morphed photographs of the first group into an aged version of what they might look like in 45 years time. After taking some time to analyze their pictures, they said they wanted to set aside an average of 6.2% of their current salary for retirement. The other group, which only saw photographs of their current selves, set aside 4.4%.

(Figure 1 from 2011 study titled “Increasing Saving Behavior Through Age-Progressed Renderings of Future Self.”  Researchers: Hal E. Herfield, Daniel G. Goldstein, William F. Sharpe, Jesse Fox, Leo Yeykelis, Laura L. Carstensen, Jeremy N. Bailenson.)

In a second study, Hershfield created aged avatars of college students so they would see themselves as 45 years older, but also interact with other people in a virtual environment.

After giving them a few minutes to take on the form of their future selves, Hershfield told them to imagine receiving an unexpected $1,000. “How much of that money would you use to open a checking account, buy something nice for someone special, plan an extravagant vacation or invest in a retirement fund?” he asked.

Compared to a group of students who only saw an avatar depicting their current self, those who took on the role of their aged self set aside more than twice as much for retirement: an average of $172 out of the $1,000 windfall.

Our eyes work in conjunction with our brain

Narrowing the focus of our visual attention — and seeing our future as part of the here and now — helps us make choices in the present that are more aligned with the people who wish to become.

That’s because when we focus on the future, we thereby contract the distance separating that far-off goal from the starting line we’re standing at now. It’s a simple trick that can truly go a long way in improving your odds of financial success.