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Investing Blog Roundup: Open Social Security (improved WEP/GPO functionality)

The Open Social Security calculator now has some new functionality for people affected by the Windfall Elimination Provision and/or Government Pension Offset.

Specifically, it allows you to enter a date on which your pension from non-covered employment will begin (so that the calculator knows not to apply the WEP/GPO until that date), and it allows you to enter what your PIA would be without the effect of the WEP (so that the calculator can account for the fact that survivor benefits are calculated based on a PIA that hasn’t been reduced by WEP).

Special thanks go to Brian Courts who not only offered the separate-PIAs suggestion but also provided code to implement the idea!

Recommended Reading

Thanks for reading!

A Rough, General-Purpose Retirement Plan

For a few years now I’ve been talking about a basic “cookie cutter” sort of Social Security plan (i.e., an approach that works reasonably well in most cases) and about factors that would suggest that a person or couple should make adjustments to such a plan.

I’ve been thinking recently that it might be fun/useful to extend that same type of thinking to a broader range of retirement planning areas. So here’s my attempt to do just that.

And just to be super clear about something that is hopefully obvious given the brevity of this article: there are many, many cases in which the suggestions below would not be the best approach for an actual person, due to their personal circumstances. I have mentioned some of the circumstances that would suggest alternative approaches, but in each of the topics below there are plenty of potential factors that I have not mentioned.

Social Security

If you’re single, delay claiming benefits until somewhere in the 68-70 range. If you’re married, the spouse with the higher earnings record files at 70, and the spouse with the lower earnings record files as early as possible (62 and 1 month in most cases).

Some of the circumstances that would suggest an adjustment to such a strategy include:

  • You are single and are in very poor health (in which case you should file earlier),
  • You are married and both spouses are in good health (lower earner should file somewhat later) or very bad health (higher earner should file somewhat earlier),
  • The lower earning spouse is working beyond age 62 (in which case they should usually wait to file until they quit work or have reached full retirement age),
  • You have minor children or adult disabled children (may be a reason for the higher earner to file earlier), or
  • You or your spouse will be receiving a government pension (could affect the decision in either direction).

Tax Planning (Retirement Account Distributions)

Try to “smooth out” your taxable income over the course of your retirement.

For example, if you retire at age 60 but don’t plan to take Social Security until 70, you have a 10-year window during which your income will be markedly lower than it has been in the past (because you’re retired) and lower than it will be in the future (because neither Social Security nor RMDs have started yet). So it’s likely wise to spend from tax-deferred accounts and likely do some Roth conversions during that 10-year window — with the goal being to shift income from future years (which would otherwise be higher-income years) into the current lower-income years (i.e., smoothing out your taxable income over time).

To be clear, that’s somewhat of a simplification. In reality you want to try to smooth your marginal tax rate — rather than taxable income — over time. That is, if your marginal tax rate now is lower than it will be later, try to shift income from future years into this year. (And it’s key to remember that your marginal tax rate is often quite different from your tax bracket, especially during retirement.)

Spending Rate

Firstly, set aside (in something safe, such as a short-term bond fund) enough money to fund any Social Security delay that will be happening. For example, if you are forgoing $150,000 of Social Security benefits by waiting from 62 until 70, set aside $150,000 in something safe in order to fund the extra spending necessary until age 70. Then, from the remainder of the portfolio, use the IRS RMD table (i.e., “Uniform Lifetime table“) to calculate a spending amount each year. And for years prior to 70, use the same overall age-based approach — with a lower rate of spending the younger you are.

We discussed this overall strategy last year, and you can find a paper here from Steve Vernon that discusses it in more depth. Broadly speaking though, basing spending on RMD percentages has two main advantages:

  • It adjusts spending over time based on portfolio performance, rather than spending a fixed inflation-adjusted amount each year of retirement, and
  • It adjusts spending based on your remaining life expectancy (i.e., it accounts for the fact that you can afford to spend a larger percentage of your portfolio per year when you are age 90 than when you’re age 60).

Circumstances that could suggest an adjustment to such a strategy:

  • You have an unusually long or short life expectancy,
  • Real interest rates are very high or very low,
  • Market valuations are very high or very low, or
  • Your portfolio makes up a relatively small part of your overall financial picture. (For instance if you have a government pension that covers all of your major needs, you can spend from your portfolio at a faster rate, if you so desire — because, unlike many retirees, you would not be in an especially bad situation if you depleted, or nearly depleted, your portfolio.)

Asset Allocation

There’s a huge range of asset allocations that could be reasonable for a retirement portfolio (i.e., the portfolio that does not include the fixed sum that is set aside for the purpose of delaying Social Security).

  • Want a 70% stock, 30% bond portfolio? Go for it.
  • Prefer a 30% stock, 70% bond portfolio? That’s cool too.
  • Want to exclude international stocks completely? Sure.
  • Prefer to have a heftier 30-50% international stock allocation? Knock yourself out.
  • Want to use only Treasury bonds for your fixed-income holdings? That’s reasonable.
  • Prefer to use a “total bond” fund instead? Super.

One key point — something that surprises many people — is that a higher stock allocation (or any allocation decision that shifts things toward more risk and more expected return) tends to result in only a relatively modest increase in the amount you can safely spend per year early in retirement. The higher expected returns are, to a significant extent, offset by the increased unpredictability. (For related reading, here’s Wade Pfau’s 2018 update to the Trinity Study — though of course that has to be considered with all the usual caveats about using historical returns to try to plan for the future.)

The more dramatic impacts of higher-risk, higher-expected return allocations are that they tend to mean more volatility (duh) and a greater chance of either a) leaving a large sum to your heirs or b) increasing spending later in retirement.

Insurance

If you are retired, you probably don’t need life insurance, as it’s likely that you have no dependents anymore. One noteworthy case in which you likely would want life insurance as a retiree would be if you still have minor children or if you have an adult disabled child. Another case in which a retiree might want life insurance is if they’re married and a major portion of their total income comes from a pension with a small survivor benefit amount.

If you are retired you almost certainly don’t need disability insurance. Disability insurance exists to replace income that you’d be unable to earn if you’re unable to work. But if you aren’t working anyway (i.e., you’re retired), you don’t need it.

Health insurance is a must-have. If retiring prior to Medicare eligibility, make sure you have a very specific, well-researched plan for health insurance. The Affordable Care Act makes it possible to get insurance, but make sure you have a good idea of the cost, and make sure you have researched plans to know what they cover — though of course it’s subject to change every year.

Long-term care insurance is a genuine predicament, regardless of what decision you make. If you don’t buy it, you could potentially be on the hook for huge costs. If you do buy it, you might be faced with premiums that rise rapidly and unpredictably. (Other related products to consider are “hybrid” long-term care annuities or long-term care life insurance, but those both have their problems as well.)

Having proper liability insurance (including an umbrella policy, in many cases) continues to be important. In fact, it’s likely more important than at any prior point, given that during retirement you are more dependent on maintaining your assets than you are at earlier stages.

As far as longevity risk (i.e., the risk of outliving your money, because you live well beyond your life expectancy), lifetime annuities (whether immediate or deferred) can provide protection. The downside is that they reduce your liquidity/flexibility, reduce the amount you’re likely to leave to your heirs, and usually come with significant inflation risk. Delaying Social Security provides the same type of protection at a much better cost — and with an inflation adjustment. So purchasing such an annuity generally only makes sense if you are already age 70 and still want additional longevity protection (or if you are already planning to delay Social Security to 70 and still want additional longevity protection).

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Investing Blog Roundup: Remembering Jack Bogle

As you have likely heard by now, Jack Bogle died this week.

There have been an abundance of great articles about him in the last two days — not just about what he achieved professionally (as monumental as those achievements were), but about what he was like as a person. That’s no coincidence. Many of us have personal stories to share.

He founded a massive company, and he revolutionized an industry, but he was as approachable as anybody I’ve met. He’d ask you what you were working on. He’d tell you about what he’d been reading lately. He’d sit next to you at lunch and discuss Social Security — sharing his opinions (he had opinions!), but also listening intently to yours.

If you’re feeling moved to do something in his memory, I have two suggestions:

  1. A donation to the National Constitution Center (Bogle served as chairman of the Center’s board for several years and often bragged about the work that they do), and/or
  2. A donation to the John C. Bogle Center for Financial Literacy.

And this is probably as good a time as any to suggest that you consider signing up to be an organ donor, if you have not yet done so. It’s easy, costs nothing, and could save somebody’s life — much as Jack’s life was saved in 1996 by somebody’s generous decision to be an organ donor.

Recommended Reading

Thanks for reading!

Open Social Security Update: Child Benefits, Retroactive Applications

A few days ago I rolled out an update for the Open Social Security calculator that includes a few new pieces of functionality:

  • Child benefits (now for married couples as well as single people),
  • Child-in-care spousal benefits, and
  • Retroactive applications.

This update took about three months of work, mostly because the “combined family maximum” rules and child-in-care spousal benefit rules are pretty complicated. (And the calculator has to be prepared to deal with any combination of uncommon complicating factors.)

If you are using the child benefit-related functionality, please be aware that the calculator will take somewhat longer to run. When minor children or disabled children are in the picture, your computer has to do a lot more math in each month of the simulations.

With regard to child-in-care spousal benefits, I expect to do a more thorough writeup of how they work in the not-so-distant future. But for now, a simplified explanation is that they’re like regular spousal benefits, with a few major differences:

  • You don’t have to be age 62 to receive them,
  • There is no reduction for entitlement prior to full retirement age, and
  • Filing for (and entitlement to) child-in-care spousal benefits does not trigger a deemed filing for retirement benefits.

As far as retroactive applications, the calculator now recommends them when a person is eligible for such and when such would be helpful. A simplified explanation of the retroactive application rules is that a person beyond FRA can backdate their application up to 6 months (or 12 months in some disability-related cases) — but no earlier than the month in which they reached full retirement age.

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Topics Covered in the Book:
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  • 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.

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Investing Blog Roundup: How Important is Sequence of Returns Risk?

I recently encountered an article from the Early Retirement Now blog, discussing just how much sequence of returns risk matters in retirement. The article isn’t new (May 2017). And it’s pretty math-heavy. But it’s worth a read.

One noteworthy finding: over a 30-year retirement, only 31% of the variation in safe withdrawal rates is explained by the average return earned by the portfolio over that 30-year period. 64%, however, is explained by the sequence of those returns.

If the math intimidates you, I would still encourage you to at least click over to the article and find the second table — the one with a column of green-highlighted cells. What these cells are showing you is how important each 5-year window of returns is in determining safe withdrawal rate.

It’s quite striking how much less important each 5-year window of returns is, relative to the prior 5-year window. For example, years 0-5 explain more than 28% of the variation in safe withdrawal rate. Years 5-10 explain another 19%. Years 10-15 explain another 13%. And so on.

Key takeaway being: the returns that your portfolio earns in the first several years of retirement matter a lot.

Other Recommended Reading

Thanks for reading, and Happy New Year!

How Do Tax Inflation-Adjustments Work?

A reader writes in, asking:

“Could you please discuss how the inflation adjustments in the tax code work? I know that they now rely on chained CPI rather than regular CPI, but when I try the math on my own I do not get the same results as the official numbers.”

The general approach is to:

  1. Multiply the dollar amount specified in the relevant Code provision by a percentage (which is essentially the inflation that has occurred in the years since the provision went into effect), then
  2. Round to a multiple of a given dollar amount.

As the reader noted in his email, such calculations now use the Chained Consumer Price Index For All Urban Consumers (C-CPI-U) rather than the regular CPI-U, with the result generally being smaller inflation adjustments than we would have seen otherwise.

Let’s look at an example.

For the tax brackets that apply from 2018-2025, the inflation adjustment for any year beginning in 2019 is the percentage by which:

  • the C-CPI-U for the preceding calendar year, exceeds
  • the C-CPI-U for calendar year 2017.

Of note: when we refer to the C-CPI-U “for a given year,” we’re talking about the average such figure for the 12-month period ending in August of that year. For example, the C-CPI-U for 2018 would be the average of the C-CPI-U figures from September 2017-August 2018.

So if we want to calculate the inflation adjusted tax brackets for 2019, we first find the average C-CPI-U from September 2016 – August 2017. That figure was 138.237. And the average Chained CPI-U for September 2017 – August 2018 was 141.078. Then we divide 141.078 by 138.237 to get 1.02055. This tells us that our tax bracket thresholds will each be increased by 2.055%, before rounding.

Rounding

After the above math is performed, the applicable figure is then rounded. The rounding rules vary from one provision to another. For instance, IRA contribution limits are rounded down to the next lower multiple of $500, whereas the income limits for Roth IRA contributions are rounded (up or down) to the nearest multiple of $1,000.

With some tax provisions, it’s common for the rounding rules to prevent us from seeing any change in many years. For instance, the IRA contribution limit was stuck at $5,500 from 2013-2018. Even though we had inflation over that period, it wasn’t enough to push the contribution limit over the next $500 threshold — until this year. (The limit will be $6,000 for 2019.)

Some Things Get No Inflation Adjustments

Finally, it’s worth noting that there are also an assortment of figures that don’t get an inflation adjustment at all (e.g., catch-up contribution limit for IRAs, or the thresholds for Social Security taxability).

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