Archives for April 2016

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Social Security Planning Questionnaire/Checklist

One thing I see over and over (both in emails from readers and in discussions on the Bogleheads forum) is that people don’t know what information they need to provide in order to get assistance with their Social Security claiming decision. In some cases, that simply means that the person providing the assistance has to request additional information. In other cases, however, it can mean that an important fact is not considered in the analysis and a poor decision is made as a result.

What follows are the pieces of information that are necessary in order to make an informed decision about when to claim Social Security.

The Basics

If you’re getting help with your Social Security decision (whether from a financial planner, the Bogleheads, or elsewhere), you will, at the very least, need to provide the following pieces of information:

  • An estimate of your primary insurance amount,
  • Your month and year of birth,
  • Whether you have filed yet for benefits of any kind, and
  • Whether you have any reason to think that your life expectancy is significantly longer or shorter than average for a person your age.

And, if you are married, you will need to provide those same pieces of information regarding your spouse.

Other Potentially Important Points

In addition to the above, there are several other pieces of information that are important to mention, if they apply to you:

  • Do you have any children under age 18, adult disabled children, or dependent parents?
  • Do you (and/or your spouse) qualify for a pension from work you did that wasn’t covered by Social Security? And if so, what is the monthly amount of that pension?
  • Will you (and/or your spouse) be working between the ages of 62 and your full retirement age? (Or between the ages of 60 and your full retirement age, if you are a widow/widower.) And if so, how much do you expect to earn per year?
  • Have you had a marriage that ended? And if so, how long did it last, did it end as a result of divorce or death, and what is the PIA of that prior spouse?
  • If you are a widow(er) and have remarried, at what age did you remarry?

One important thing to note about the above situations is that they are often overlooked by the online Social Security planning calculators. If one of the above situations applies to you and the calculator you’re using doesn’t ask about that information, then the recommendation from the calculator is likely to be very flawed.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Social Security: Should I File and Suspend Before 4/30/2016?

I’ve been getting a lot of questions from readers this month about the upcoming “file and suspend” deadline. So let’s go through this one final time, as succinctly and clearly as possible.

First, let’s make sure we’re clear on the deadline itself, as there has been a lot of misinformation on that topic. If you request suspension of benefits by 4/29/16 or earlier, the old rules will apply to your request. If the SSA receives your request to suspend benefits on 4/30/16 or later, the new rules will apply.

If you meet all of the following requirements, it likely makes sense for you to file and suspend (i.e., file for your own retirement benefit and ask to have it suspended) prior to 4/30/2016.

One: You attain* full retirement age prior to the deadline. (You cannot request suspension of benefits until you have reached full retirement age.)

Two: You plan to delay your own retirement benefit beyond full retirement age. (If you want to actually receive your retirement benefit, suspending it obviously isn’t a good idea.)

Three: You want somebody else (e.g., your spouse) to be able to receive a benefit based on your work record prior to the point at which you actually start receiving your retirement benefit. Or you want to preserve the ability to retroactively unsuspend later as a “change your mind” strategy.

Four: You do not intend to receive spousal benefits on your spouse’s work record between your FRA and age 70. (If you want your own retirement benefit to continue growing while you collect spousal benefits, you have to file a “restricted application” for just spousal benefits. But if you file and suspend, you are by definition filing for your own retirement benefit — rather than filing for spousal-only — and that will really mess up your plan.)

*In the world of Social Security, you “attain” an age on the day before your birthday.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Do Vanguard Funds Have Hidden Costs?

A reader writes in, asking:

“I recently met with a financial advisor to look over my portfolio. Currently, I use the ‘three fund portfolio’ that is recommended on the Bogleheads website: Vanguard’s total stock, total international, and total bond funds. The advisor said that while Vanguard index funds are OK, he thinks they’re over-rated because they have hidden costs and they aren’t actually as cheap as Vanguard states in their marketing. Is that true?”

Every typical mutual fund (index or otherwise) has “hidden costs” as a result of portfolio turnover. That is, when a mutual fund buys or sells investments, it incurs costs in the form of commissions and bid/ask spreads. And these costs are hidden in the sense that they are not included in the fund’s reported expense ratio, despite the fact that they have a downward drag on performance.

What’s ironic about this advisor’s assertion is that:

  1. Index funds (especially “total market” funds) tend to have very low turnover costs, and
  2. It’s much easier to estimate an index fund’s turnover costs than an actively managed fund’s turnover costs.

In other words, relative to the hidden costs of actively managed funds, the hidden costs of index funds are typically a) less hidden and b) lower.

Why Index Funds Usually Have Lower Turnover Costs

The reason why index funds typically incur lower portfolio turnover costs than actively managed funds is simple: index funds generally have a lower rate of portfolio turnover.

For example, Morningstar currently reports that Vanguard Total Stock Market Index Fund has annual portfolio turnover of just 3%. Look up any handful of actively managed stock index funds, and the most likely outcome is that all of them will have portfolio turnover well in excess of 3% per year.

How to Estimate the Turnover Costs of an Index Fund

With index funds, it’s pretty easy to get an idea of the magnitude of such hidden costs. To do so, check how the fund’s long-term performance compares to the performance of the index that it tracks. For example if:

  • A given index has an annual return of 7.0% over the last 10 years,
  • A particular index fund tracking that index has a return of 6.85% over those 10 years, and
  • The fund has an expense ratio of 0.1%…

…then we can estimate that the fund’s “hidden costs” are in the ballpark of 0.05% per year. (That is, if the fund’s performance trails the performance of its benchmark by 0.15% per year, and the fund has a 0.1% expense ratio, the remaining 0.05% performance gap serves as a decent estimate of such “hidden” portfolio turnover costs.)

With regard to the advisor’s assertion about Vanguard specifically, it’s worth pointing out that, in many cases, Vanguard’s index funds actually trail their benchmarks by an amount that’s less than their expense ratios. In other words, the hidden costs are sufficiently small that they are outweighed by the “hidden revenue” the funds earn from securities lending.

Can You Double-Count Earnings for IRA and 401(k) Contributions?

A reader writes in, asking:

“My spouse is retired, and I recently began semi-retirement, working just a few days each month. Because of a pension and paid off house, we won’t be spending from our retirement savings. My question regards contributions to retirement accounts with a small amount of income.

My employer offers a 401k. Let’s say I earn $10,000 in 2016. Can my wife and I each contribute the maximum to a Roth IRA? Essentially what I’m asking is can we each count the $10,000 as income? And does that change if I contribute to the 401k?”

First let’s back up a step for readers unfamiliar with this topic. In addition to the normal IRA contribution limits, there is also a rule which says that your IRA contributions for each year are limited to your compensation for that year (i.e., wages, commissions, self-employment earnings, alimony, and nontaxable combat pay).

There is an exception to this compensation-related limit for married people, but for the moment let’s focus on the simpler situation of an unmarried person.

Contributing to a 401(k) and IRA

Your IRA contribution is limited to your compensation for the year. For people earning wages (as opposed to self-employment income) the relevant amount is the amount reported in box 1 of Form W-2. Of note, that figure has already been reduced by any pre-tax (i.e., “traditional”) 401(k) contributions that you make for the year. In other words, if your earned income is low enough, contributing to a pre-tax 401(k) would reduce the amount of IRA contributions that you can make.

Example: Beth earns $5,000 this year. If she doesn’t contribute anything to a retirement plan at work, she can contribute the entire amount to a Roth IRA.* However, if her employer offers a 401(k) and she decides to make pre-tax contributions to that plan, those contributions would reduce the amount of wages that show up in box 1 on her W-2, thereby reducing the amount she can contribute to her Roth IRA.

Things work differently, however, if it is a Roth 401(k) to which you are contributing at work. Specifically, the amount of wages reported in box 1 on Form W-2 is not reduced by the amount of Roth 401(k) contributions that you make. In other words, you can essentially “double count” your earned income by contributing to a Roth 401(k) and a Roth IRA.

Example: Beth earns $5,000 this year. If she contributes $5,000 to a Roth 401(k), she can still contribute $5,000 to a Roth IRA.

Spousal IRA Contribution Limits

As mentioned above, there is an exception to the rule that your IRA contributions for each year are limited to your compensation for that year. Specifically, in a married couple, for the spouse with the lower amount of compensation for the year, the compensation-related limit is calculated as:

  1. The compensation of the spouse in question, plus
  2. The compensation of the other spouse (i.e., the one with higher earnings), minus
  3. Any IRA contributions the other spouse (the higher-earning one) has made for the year.

Example: Bob and Jane are married, both age 60. Bob is retired. Jane still works part-time, earning $20,000 per year. Jane does not contribute to a retirement plan at work. She does, however, contribute $6,500 to a Roth IRA for the year. Despite having zero compensation for the year, Bob can also contribute $6,500 to a Roth IRA, because Jane’s compensation is sufficiently high for both of them to make contributions.*

A key point here is that spousal IRAs do not allow for “double counting” of income. For example, if Jane in our previous example only earned $5,000 for the year and she contributed $5,000 to a Roth IRA, Bob wouldn’t be able to make any Roth IRA contribution.

*For the sake of simplicity, we are assuming here that the MAGI-related income limits are not an issue.

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My new Social Security calculator (beta): Open Social Security