Consider the Risks of Relying on Social Security

The 58 million Americans who currently receive Social Security benefits will not receive a cost-of-living adjustment (COLA) in 2011. This is the second consecutive year in which payments were frozen because the Consumer Price Index measured little or no inflation.¹

Although the decision to freeze benefits in 2011 is not directly related to the social insurance program’s projected funding shortfall, consider it a lesson in the risk of relying too heavily on a program that has a potentially uncertain future. Millions of Americans who rely on Social Security just found out that they won’t receive an anticipated benefit increase — and they learned this only a few months in advance, too late for them to do much about it.
Given that nothing like this has happened before, the disappointment among Social Security beneficiaries may have been compounded by an element of surprise: 2010 was the first year since 1975, when Social Security instituted automatic COLAs tied to the rate of inflation, in which benefits did not increase year-over-year.² It’s likely that many retirees believed that the lack of a COLA in 2010 meant that one would be virtually guaranteed in 2011 because it would be unheard of for the government to go two years without increasing benefits. But that is exactly what has happened.
Going forward, it might be prudent to expect more surprises from Social Security. The program’s already fragile situation has deteriorated further in the face of widespread unemployment and a significant reduction in the payroll tax receipts that fund the government’s largest program. The Congressional Budget Office now expects that in 2010, Social Security outlays will exceed tax revenues for the first time since Social Security was amended in 1983. Although the CBO expects that revenues will generally equal outlays over the next few years, growing numbers of retiring baby boomers will eventually overwhelm the system and cause outlays to regularly exceed tax revenues by 2016. The CBO also projects that Social Security’s so-called trust funds, which are actually IOUs issued by Congress for borrowing Social Security’s surplus revenues in years past, will be exhausted by 2039 if no changes are made to current laws.³

What if It Happened to You?

Imagine what your own financial situation might look like if Social Security announced shortly before your anticipated retirement date that, because of underfunding, it would cut benefits and raise eligibility requirements.
Although these measures have not been adopted, it’s worth noting that they are being considered. The Congressional Budget Office has studied policy options that include reducing benefits, raising the retirement age, limiting future COLAs, and increasing payroll taxes.⁴ Because there is little consensus among lawmakers or the public, a solution reached by political negotiation could combine several different measures.
Fortunately, Social Security’s precarious financial situation has not gone unnoticed. Seventy-seven percent of Americans now believe the enormous cost associated with entitlement programs like Social Security and Medicare will eventually create major economic problems for the nation if they are left unchecked.⁵ Fifty-six percent of retirees believe they will eventually suffer a cut in their benefits, and 60% of workers have expressed doubt they will ever receive Social Security payments.⁶
It seems clear that, at the very least, Social Security will not be able survive without making some adjustments. The good news is that you are already aware of the likelihood, so it might be wise to prepare for your own retirement on the assumption that Social Security won’t be able to provide the same level of benefits that you might currently be expecting. Better to make such an assumption now, and begin seeking ways to offset the potential shortfall, than wait until it’s too late to do anything about it.

1–2) Social Security Administration, 2010
3–4) Congressional Budget Office, 2010
5–6) Gallup, 2010

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.

What Is the Most Tax-Efficient Way to Take a Distribution from a Retirement Plan?

 If you receive a distribution from a qualified retirement plan, such as a 401(k), you need to consider whether to pay taxes now or to roll over the account to another tax-deferred plan. A correctly implemented rollover can avoid current taxes and allow the funds to continue accumulating tax deferred.

 

Paying Current Taxes with a Lump-Sum Distribution

 

If you decide to take a lump-sum distribution, income taxes are due on the total amount of the distribution and are due in the year in which you cash out. Employers are required to withhold 20 percent automatically from the check and apply it toward federal income taxes, so you will receive only 80 percent of your total vested value in the plan.

 

The advantage of a lump-sum distribution is that you can spend or invest the balance as you wish. The problem with this approach is parting with all those tax dollars. Income taxes on the total distribution are taxed at your marginal income tax rate. If the distribution is large, it could easily move you into a higher tax bracket. Distributions taken prior to age 59½ are subject to an additional 10% federal income tax penalty.

 

If you were born prior to 1936, there are two special options that can help reduce your tax burden on a lump sum.

 

The first special option, 10-year averaging, enables you to treat the distribution as if it were received in equal installments over a 10-year period. You then calculate your tax liability using the 1986 tax tables for a single filer.

 

The second option, capital gains tax treatment, allows you to have the pre-1974 portion of your distribution taxed at a flat rate of 20 percent. The balance can be taxed under 10-year averaging, if you qualify.

 

To qualify for either of these special options, you must have participated in the retirement plan for at least five years and you must be receiving a total distribution of your retirement account.

 

Note that these special tax treatments are one-time propositions for those born prior to 1936. Once you elect to use a special option, future distributions will be subject to ordinary income taxes.

 

Deferring Taxes with a Rollover

 

If you don’t qualify for the above options or don’t want to pay current taxes on your lump-sum distribution, you can roll the money into a traditional IRA.

 

If instead you choose a rollover from a tax-deferred plan to a Roth IRA, you must pay income taxes on the total amount converted in that tax year. However, future withdrawals of earnings from a Roth IRA are free of federal income tax as long as the account has been held for at least five tax years.

 

If you elect to use an IRA rollover, you can avoid potential tax and penalty problems by electing a direct trustee-to-trustee transfer; in other words, the money never passes through your hands. IRA rollovers must be completed within 60 days of the distribution to avoid current taxes and penalties.

 

An IRA rollover allows your retirement nest egg to continue compounding tax deferred. Remember that you must begin taking annual required minimum distributions (RMDs) from tax-deferred retirement plans after you turn 70½ (the first distribution must be taken no later than April 1 of the year after the year in which you reach age 70½). Failure to take RMDs subjects the funds that should have been withdrawn to a 50 percent federal income tax penalty.  

 

Of course, there is also the possibility that you may be able to keep the funds with your former employer, if allowed by your plan.

 

Before you decide which method to take for distributions from a qualified retirement plan, it would be prudent to consult with a professional tax advisor.

 

The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor.

 

This material was written and prepared by Emerald.
© 2010 Emerald

 

An Estate is a Terrible Thing to Waste

If you have a current will, consider yourself ahead of most Americans when
it comes to estate planning. In fact, a recent survey found that an alarming
70% of Americans don't have this most basic estate conservation document.1

With a will, you can direct the probate courts that oversee the distribution of
your estate. You can also name legal guardians for minor children and their
inherited assets.

A will is certainly the best place to start. However, the goal of any estate
strategy should be a smooth transfer of wealth to your heirs, and it may
take more than simply having a current will.

Powers of Attorney

Powers of attorney are used to designate someone to make financial and/or
medical decisions on your behalf. Powers of attorney can be specific,
designating your agent to act for you only in certain circumstances, or they
can be general, giving your agent the authority to make any and all
decisions on your behalf. You may want to create separate powers of attorney
for finances and medical care.

Beneficiary Designations

It's a good idea to make sure that the beneficiary designation forms for
your retirement plans and life insurance policies are properly completed and
accurate. Retirement plan assets and life insurance proceeds are generally
exempt from the probate process and transfer directly to the designated
beneficiaries.

Trusts

A trust is a separate legal entity that holds your assets and distributes
them according to your wishes. Some trusts can help reduce estate taxes or
place conditions on heirs who inherit your property. Others can be used to
make charitable donations, to provide for family members with special needs,
and to help prevent posthumous challenges from disgruntled parties.

The use of trusts can involve a complex web of tax rules and regulations.
You should consider the counsel of an experienced estate planning
professional before implementing such strategies.

Even a comprehensive estate strategy may be of limited use if it is out of
date. You can help ensure the effectiveness of your strategy by periodically
reviewing your will, powers of attorney, and beneficiary designation forms
to verify that they are current.

1) LegalZoom.com, 2010

The information in this article is not intended as tax or legal advice, and
it may not be relied on for the purpose of avoiding any federal tax
penalties. You are encouraged to seek tax or legal advice from an
independent professional advisor. The content is derived from sources
believed to be accurate. Neither the information presented nor any opinion
expressed constitutes a solicitation for the purchase or sale of any
security.



This material was written and prepared by Emerald. C 2010 Emerald.