Tag: COLA

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 1 of 2

There have been many articles and blog posts over the last several years about the ability to delay your Social Security retirement benefit start date in order to increase your monthly benefit. I wrote about this in my March 4, 2013 post, Increase Your Longevity Risk with Social Security. Per the post, with a choice of start dates ranging between 62 through 70, you can increase your benefits 7% – 8% each year that your start date is deferred, excluding cost-of-living adjustments (“COLA’s”).

Sources of sustainable lifetime income are few and far between these days with the widespread elimination of monthly pension benefits. The ability to receive a stream of sustainable lifetime income throughout retirement while also choosing your income start date is a rare planning opportunity, the value of which shouldn’t be underestimated.

While the opportunity to receive sustainable lifetime income with a flexible start date is limited, Social Security isn’t the only game in town. If the security of sustainable lifetime income appeals to you and you want to create one or more income streams, fixed income annuities offered by life insurance companies, preferably ones that are highly rated, will also meet your need.

There are three types of fixed income annuities, all of which are contractually guaranteed by the life insurance company from which they are purchased. The three types are single premium immediate annuities (“SPIA’s”), deferred income annuities (“DIA’s”), and fixed index annuities (“FIA’s”) with income riders.

There are several important differences between the three types of fixed income annuities that have been discussed in several Retirement Income Visions™ posts. One of the differences that are relevant to this post is the income start date. SPIA’s and DIA’s have contractually defined income start dates, while the start date of FIA’s with income riders is flexible.

SPIA’s are the most restrictive with a start date that begins one month after the contract is issued, assuming a monthly payment mode is chosen. When you purchase DIA’s, you choose the income start date at the time of application. It is contractually defined with the provision that it cannot begin earlier than 13 months after your contract is issued.

Please read Part 2 of this post next week to learn about the income start date flexibility available with FIA’s with income riders that are designed to provide you with sustainable retirement income when you need it.

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Annuities Fixed Index Annuities Social Security

Delayed Gratification is the Key to Maximizing Income with Fixed Index Annuities

When you’re planning for retirement, income is the name of the game. The more sustainable income that you can generate, the less you need to worry about things like sequence of returns and major stock market downturns – before and during retirement.

The idea is to build a base, or floor, of predictable income that will cover your day-to-day expenses. For most people doing retirement income planning, Social Security is the core element of an income floor. Although pre-retirees today can plan to receive a full Social Security benefit beginning somewhere between age 66 and 67 depending upon their year of birth, the benefit that they, and potentially their spouse, will receive will increase by 8% per year for each year that they defer their start date up until age 70. This equates to as much as a 24% – 32% greater benefit depending upon your year of birth and how long you defer your start date.

Assuming that your goal is to build a solid base of sustainable income with the ability to increase your lifetime income amount similar to Social Security, one of the best ways to do this is to invest in a flexible fixed index annuity (“FIA”) with an income rider. The reason that you want to use a flexible, vs. a single, premium FIA is to provide you with the ability to add to your investment should you choose to do so. In addition, you need to purchase an income rider, which is optional with most FIA’s, in order to receive guaranteed (subject to the claims-paying ability of individual insurance companies) income.

Like Social Security, the longer you wait to begin receiving your income, the greater it will be. Unlike Social Security benefits which are increased by cost of living adjustments (“COLA’s”), the lifetime income from the majority of FIA’s available today will remain unchanged once it’s started.

To demonstrate the benefit of deferring the start date of FIA income withdrawals, let’s use one of the contracts purchased by my wife and me two years ago when we were 55 and 48, respectively. I will use my wife’s age as a point of reference for the remainder of this post since income withdrawal amounts are always calculated using the younger spouse’s age.

Per our annuity contract, my wife and I are eligible to begin income withdrawals at least 12 months after our contract was issued provided that both of us are at least age 50. It generally doesn’t make sense to take withdrawals from a FIA income rider before age 60 since the formula used to calculate the withdrawal amount is less favorable and the withdrawals will be subject to a 10% IRS premature distribution penalty and potentially a state penalty. Assuming that we plan on retiring after my wife is 60, there would be no need to begin income withdrawals before this age.

I have prepared a spreadsheet with various starting ages in increments of five years beginning at 55 through 75. The spreadsheet shows the projected percentage increase in our annual income withdrawal amount that we will realize by deferring our income start age compared to ages that are 5, 10, 15, 20, and 25 years younger, depending upon the starting age chosen.

Using an example that’s comparable to the Social Security starting age decision, suppose that we decide to defer our income start age from 65 to 70. This would result in a 31.2% annual increase in lifetime income. We will receive 120.3% more income if we begin our income withdrawals at age 70 instead of at 60. The percentage increases are significant in many cases depending upon the chosen withdrawal starting age compared to another potential starting age.

Similar to the Social Security starting age decision, there are numerous factors that need to be considered when determining the optimal age to begin income withdrawals from a FIA with an income rider, a discussion of which is beyond the scope of this post. Like Social Security, when possible and it makes sense, delayed gratification is the key to maximizing lifetime income.

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Social Security

Insure Your Longevity Risk with Social Security

When planning for retirement, you need to plan for all of your retirement years. Sounds obvious, however, too often there’s a focus on living it up in the early years without fully considering the potential for longevity and financial risks associated with the later years. As stated in previous posts, the consequences of the financial decisions that you make before you retire can have a profound effect on your ability to meet your financial needs throughout your later retirement years.

How do you plan for all of your retirement years if you don’t know how long you’re going to live? The answer is longevity insurance, otherwise known as a lifetime income annuity. This type of investment will pay you a specified amount of income beginning at a specified date at specified intervals, e.g., monthly or quarterly, with potential annual payment increases for the duration of your life.

If you’re married, the payments can continue to be paid to your spouse upon your death at the same or a reduced amount, depending upon the contractual terms of the particular annuity. Unlike equity-based investments, the payments will be made regardless of market performance.

One of the best longevity insurance planning tools that most of us have at our disposal is Social Security. With its lifetime income payments, not to mention flexible starting date, i.e., age 62 through 70, and associated 7% – 8% increase in benefits each year that the starting date is deferred, excluding cost-of-living adjustments (“COLA’s”), we can use it to insure our, and, if married, our spouse’s, longevity risk.

The amount of retirement income that we choose to insure with Social Security is a personal decision. It’s dependent upon several factors, including, but not limited to, projected investment assets and liabilities, other projected sources of income and expenses and projected timing and duration of same, as well as income tax laws and projected income tax rates.

Delayed claiming of Social Security benefits, in addition to providing increased annual lifetime benefits, results in greater longevity insurance since there will be more guaranteed income available in the latter years of retirement when it may be needed the most. The ability to delay one’s Social Security benefit start date needs to be determined within the context of an overall retirement income planning analysis that includes an analysis of various potential retirement dates.

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Social Security

The Almost Irrevocable Retirement Income Planning Decision

I don’t know about you, however, I appreciate and enjoy flexibility in my life. When I hear the word “irrevocable,” other than in the phrase “irrevocable life insurance trust,” which I know from many years of experience is a wonderful estate planning tool in the right situation, I get a little squeamish. As Duke Frederick says to Celia in Scene 3 of Act 1 of Shakespeare’s As You Like It, “Firm and irrevocable is my doom.”

As pointed out in the December 17, 2012 post, Approaching 62? – Stop Before You Leap – Part 2 of 2, with two exceptions, the choice of your Social Security start date is an irrevocable decision. This wasn’t always the case. Although it wasn’t well-publicized and wasn’t used very often, the “do-over,” or “pay-to-play” strategy as I liked to refer to it, enabled individuals who claimed Social Security at age 62 to repay 100% of their benefits received to date without interest and receive a higher benefit going forward based on their current age. Ironically, Social Security Administration ended the ability to use this strategy on December 10, 2010, four days after the third of a three-part series on this topic was published by Retirement Income Visions™ (see Pay-to-Play Social Security – Part 3 of 3).

Once you start receiving your Social Security retirement benefits, why would you want to stop receiving them? As pointed out in last week’s post, benefit amounts will increase by 7% – 8% each year that the start date is deferred between age 62 and 70, excluding cost-of-living adjustments (“COLA’s”). You may have started your benefits at age 62 or some other age before your full retirement age (“FRA”) since you thought this made sense at the time and later realized this wasn’t the right choice in your situation. Another possibility is that you learned about a strategy to suspend and restart your benefits at a later date in order to receive a larger monthly payment.

Stopping Social Security Before Your Full Retirement Age

Unlike the now defunct “do-over” strategy where you could repay 100% of your benefits received to date without interest at any time after you began receiving them, there’s a limited exception that enables you to employ a scaled-down version of this strategy. If you claimed benefits before your FRA and you’re within 12 months of when your benefits started, you can withdraw your application and stop your benefits by repaying 100% of what you received so far.

Stopping Social Security After Your Full Retirement Age

Between FRA and age 70, Social Security Administration allows you to suspend retirement benefit payments. This can be done either when you’re approaching your FRA and haven’t started receiving benefits yet or after you have reached FRA and are already receiving benefits. There are different reasons why you would want to do this that’s beyond the scope of this post.

While there are two exceptions when it comes to the irrevocability of the Social Security start date that may or may not be beneficial in a particular situation, these are limited exceptions. As emphasized in the last post, the age at which you begin receiving Social Security retirement benefits may possibly be the most significant factor in your ability to sustain financial security throughout retirement. As Billy Joel says in his song, Get it Right the First Time, “Get it right the first time, that’s the main thing. I can’t afford to let it pass. Get it right the next time, that’s not the same thing.”

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Social Security

Approaching 62? – Stop Before You Leap – Part 2 of 2

Last week’s post began a discussion regarding the far-reaching and long-term consequences of the Social Security claiming decision. It concluded by stating that the choice of a Social Security starting age will differ depending upon each person’s unique circumstances.

Why is the choice of a Social Security start date so important? There are several reasons, all of which can be divided into two categories:  (a) Those dictated by Social Security rules and regulations and (b) Other fianncial reasons.

Reasons Dictated by Social Security Rules and Regulations

Social Security rules and regulations affecting the choice of a start date include the following:

  • Benefit amounts will increase by 7% – 8% each year that the start date is deferred between age 62 and 70, excluding cost-of-living adjustments (“COLA’s”).
  • Social Security COLA amounts will be greater for those who defer their start date.
  • If married, it will affect the amount of one’s spousal Social Security benefit.
  • If married, it will affect the amount of one’s survivor’s Social Security benefit.
  • With two exceptions, it’s an irrevocable decision.

Other Financial Reasons

Other financial reasons why the choice of a Social Security start date is so important include the following:

  • It can affect the choice of one’s retirement age as well as that of one’s spouse if married.
  • It may impact sustainability of retirement income and assets for 30 to 40 years.
  • It will influence the amount and timing of withdrawals from retirement and nonretirement investment assets.
  • It can affect the amount of Social Security benefits that are taxable each year.
  • It will directly affect one’s overall income tax liability and tax planning.

As you can see, there are many things riding on the choice of one’s Social Security starting age, most of which won’t become apparent until several years, or even decades, after the claiming age decision has been made. The age at which you begin receiving Social Security retirement benefits may possibly be the most significant factor in your ability to sustain financial security throughout retirement. Given the importance of this decision, sit down with your retirement income planner before going to the “Boldly Go Online to Retire – It’s So Easy!” section of the Social Security Administration website and clicking the “Apply for Retirement” link.

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Deferred Income Annuities Social Security

Social Security – The Ultimate Deferred Income Annuity

Last week’s post made the point that Social Security isn’t simply an entitlement program and is instead a deferred income annuity (“DIA”) payable for life. As discussed, the primary difference between Social Security and a commercial DIA is the organization from which the investment is purchased and payments are guaranteed. In the case of Social Security, it’s the federal government while DIA’s are purchased from, and payments guaranteed by, individual life insurance companies.

It turns out that in today’s low-interest rate environment, Social Security is inarguably the ultimate DIA. To illustrate this, I will use my current Social Security benefits statement that includes the following information about my projected monthly retirement benefit beginning at various ages:

Age 62                                                        $1,870
Age 66 and 2 months (full retirement)    $2,559
Age 70                                                        $3,385

In addition to projected monthly retirement benefits, my statement also shows that through 2011, I have paid Social Security taxes totaling approximately $149,000 and my employers (including myself and my two corporations for the last 23 years) have paid approximately $94,000, for a total of approximately $243,000.These taxes have been paid over the last 40 years beginning with part-time employment when I was in high school, with the vast majority paid over the last 25 years.

In addition to my Social Security retirement benefit, my wife is entitled to receive a monthly benefit equal to one-half of my full retirement benefit, or $1,280 (50% x $2,559) if she starts receiving benefits at her full retirement age. This is referred to as a spousal benefit and is independent of any benefit to which she may be entitled based on her earnings record. Assuming my wife has no significant earnings and further assuming that I predecease her, she will receive her spousal benefit for the rest of my life at which time she will receive my higher monthly benefit for the remainder of her life.

Ignoring my wife’s spousal benefit in order to minimize complications, let’s demonstrate the value of my Social Security retirement benefit by calculating the single premium required today at my age 57 to purchase a DIA that will pay my projected monthly retirement benefit beginning at various ages with a 2% annual increase for the remainder of my wife and my lives. Per the November 12, 2012 The Smooth COLA post, Social Security cost-of-living adjustments (“COLA’s”) have averaged 2.6% over the last ten years; therefore, an assumed 2% annual increase is probably conservative.

The following is the range of DIA single premiums required to pay various joint lifetime income amounts assuming an annual 2% increase beginning at various ages using illustrations from three highly-rated life insurance carriers:

While it’s obvious that the above single premium amounts are significantly greater than the total Social Security taxes of $243,000 paid through 2011 by my employers and myself, it’s important to keep in mind the following facts when doing a cost/benefit analysis of Social Security compared to commercial DIA’s:

  • In order to receive the projected Social Security monthly income beginning at various ages, it’s assumed that my current earnings will continue until my full retirement age.
  • In order to receive the projected Social Security monthly income beginning at various ages, Social Security taxes paid by my employers and myself are projected to total $314,000 – $381,000 or greater depending upon my annual earnings, actual taxable Social Security wage bases, and when I retire.
  • Although my Social Security tax payments haven’t been segregated and invested in an account in my name and they have been used to fund Social Security benefits for other individuals, my employers and I have been paying into the Social Security Trust Fund for 40 years.
  • My projected Social Security monthly income beginning at various ages doesn’t include COLA’s between now and my Social Security starting age.
  • The DIA assumed annual increase of 2% may be greater or less than the actual Social Security COLA’s for the remainder of my wife and my lifetime.
  • Although it isn’t likely, it’s possible that my projected Social Security benefit amounts may change if Social Security law changes.
  • As previously stated, my projected Social Security benefits and the single premium DIA calculation both exclude my wife’s Social Security spousal benefits.
  • While it’s possible that less than 50% of my Social Security benefits will be taxable, under current law, it’s likely that 50% – 85% of my benefits will be taxable, depending upon the amount of my other income.
  • Depending upon when I would start receiving payments from a DIA, approximately 40% – 60% of my payments would be taxable as a result of favorable tax treatment associated with nonqualified annuity payments.
  • The required DIA single premium amounts are on the high side since they were calculated assuming that I’m a California resident when I receive my payments and, as such, take into consideration California’s nonqualified annuity premium tax of 2.35% which isn’t applicable in most states.

As you can see, a number of factors must be considered when comparing Social Security as a DIA to purchasing a commercial DIA. Despite these various factors, in today’s low-interest rate environment, it’s clear that Social Security is the ultimate DIA.

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Social Security

The Smooth COLA

Remember the old Dr Pepper commercials promoting the fact that this famous soft drink, which was created in the 1880s and was first nationally marketed in the United States in 1904, was “so misunderstood.” I’m a firm believer that this saying also applies to a non-soft drink COLA brought to you by the Social Security Administration.

Every year since 1975, the Social Security Administration calculates a cost-of-living adjustment, or COLA. The 1975 – 1982 COLAs were effective with benefits payable for June in each of those years. Since 1982, COLAs have been effective with benefits payable for December.

The COLA has always been based on an annual increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Since 1983, COLAs have been calculated using increases in the CPI-W from the third quarter of the prior year to the corresponding quarter of the current year in which the COLA became effective. The 2012 COLA of 1.7% was announced in October and will apply to benefits payable beginning in December.

Per the Social Security Cost-of-Living Adjustments table below, there were sizeable annual increases the first eight years from 1975 to 1982. The increases ranged from a low of 5.9% in 1977 to a high of 14.3% in 1980, averaging 8.7% during this period. The COLA decreased to 3.5% in 1983 and further declined to 1.3% in 1986 before climbing to over 4% for four straight years beginning in 1987. There have been only two years since 1982 when the COLA exceeded 5% (1990 – 5.4% and 2008 – 5.8%). There were also two consecutive years recently in 2009 and 2010 that saw no increases.

Since its roaring start the first eight years, average COLA increases have declined dramatically and have remained consistent over extended periods of time. They have averaged 2.6%, 2.5%, and 2.9% for the last 10-, 20-, and 30-year periods, respectively. As a result of their initial jump start, COLA’s have averaged 4.1% over their 38 years of existence.

Although average annual increases have remained below 3% for extended periods of time over the last 30 years, Social Security recipients have kept up with inflation as measured by the CPI-W. Someone still alive today who started receiving benefits in 1975 has seen a 354% increase in benefits, with 108% of the increase attributable to COLA’s during the first 10 years. For the individual who began receiving benefits in 1982, her benefits have increased by 134% over the last 30 years. Benefits have doubled over the last 25 years as a result of COLA’s.

With only two COLA’s exceeding 4% in the last 20 years (4.1% in 2005 and 5.8% in 2008), the pace of the total increase in Social Security benefits has declined significantly. If you began receiving benefits 20 years ago in 1992, you have seen an increase of 63%. If your start year was 2002, your benefits have increased by 29%. Finally, the total increase over the last five years has been only 11%.

Despite the fact that Social Security recipients have enjoyed sizeable cumulative increases in their benefits over the past 20+ years, another reason why COLAs are often misunderstood is due to their accounting treatment. Social Security benefits are reduced by the Medicare Part B premium that helps pay for doctors’ services and outpatient care. The monthly premium for most individuals in 2012 is $99.90. Although Medicare premium increases cannot be greater than the COLA, Social Security benefit increases are diluted to the extent of any increase in Medicare premium.

Enjoy your COLA’s!

 

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Financial Planning Retirement Asset Planning Retirement Income Planning

Is Your Retirement Plan At Risk?

Retirement Income Center

Before I write about the specific risks associated with retirement asset planning and the strategies that retirement income planners use to address, and, in many cases, mitigate, these risks, let’s take a look at risks that are common to all retirement planning. While many of these are uncertain and/or uncontrollable, each of them needs to be addressed in a retirement plan.

The risks that will be discussed are as follows, with the first three common to all types of financial planning, and each one intended to be a brief introduction vs. a comprehensive discussion:

  1. Inflation
  2. Investment
  3. Income tax
  4. Longevity
  5. Health
  6. Social Security benefits reduction

Inflation

Although it is unpredictable as to amount and fluctuation as it pertains to individual and overall variable expenses, a key risk that must be considered in the design and funding stages of all retirement plans is inflation. Unlike most types of financial planning where it is a factor only in the accumulation phase, inflation is equally, if not more important, during the withdrawal stage of retirement planning. The longer the time period, the more magnified are the differences between projected vs. actual inflation rates insofar as their potential influence on the ultimate success of a particular retirement plan.

Investment

Unless you are living solely off of Social Security or some other government benefit program, you are directly or indirectly exposed to investment risk. Even if you are receiving a fixed monthly benefit from a former employer, although it isn’t likely, your benefit could potentially be reduced depending upon the investment performance of your former employer’s retirement plan assets and underlying plan guarantees. Whenever possible, investment risk should be maintained at a level in your portfolio that is projected to sustain your assets over your lifetime while achieving your retirement planning goals, assuming that your goals are realistic.

Income Tax

Even if income tax rates don’t change significantly as has been the case in recent years, income tax can consume a sizeable portion of one’s income without proper planning. With the exception of seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) that have no personal income tax and two states (New Hampshire and Tennessee) that tax only interest and dividend income), the rest of us need to be concerned about, and plan for, state, as well as, federal income tax. In addition, if you have a sizeable income, it is likely that income tax legislation will be enacted that will adversely affect your retirement plan on at least one occasion during your retirement years.

Longevity

Unlike other types of financial planning, the time period of retirement planning is uncertain. Although life expectancies are often used as a guide to project the duration of a retirement plan, no one knows how long someone will live. The risk associated with the possibility of outliving one’s assets is referred to as longevity risk. In addition, life expectancies, themselves, are changing from time to time. The August 19, 2009 edition of National Vital Statistic Reports http://bit.ly/pAgRk announced a new high of nearly 78 years for Americans. Planning is further complicated for married individuals since you are planning for multiple lives.

Health

An extremely important risk that is sometimes overlooked or not given enough consideration in the design of retirement plans is health. Under-, or uninsured, long-term care events as well as premature death in the case of a married couple, can deal a devastating blow to an otherwise well-designed retirement plan. It is not unusual for a prolonged long-term care situation, such as Alzheimer’s, if not properly planned for, to consume all of one’s retirement capital and other assets. Inadequate life insurance to cover the needs of a surviving spouse can result in dramatic lifestyle changes upon the first spouse’s death.

Social Security Benefits Reduction

Once considered to be unshakable, the security of the Social Security system, including the potential amount of one’s benefits, is questionable. In addition, it was announced in May that for the first time in more than three decades Social Security recipients will not receive a cost of living adjustment, or COLA, increase in their benefits next year. While beneficiaries have received an automatic increase every year since 1975, including an increase of 5.8% in 2009 and a 14.3% increase in 1980, this will not be the case in 2010.

Each of the foregoing six risks needs to be considered, and appropriate strategies developed, in the design and implementation of every retirement plan to improve the chances of success of the plan.