Social Security – Essential Tidbits on Early Benefits

We normally estimate that we need the same pre-retirement spending budget plus taxes to meet minimum retirement cash flow. Since Social Security was created to be a safety net, it only covers at most 40% of needed retirement cash flow. It is for this reason that additional savings are required to support retirement lifestyle cash flow.

The most important aspect of Social Security is that it is a lifetime benefit that is inflation adjusted and therefore holds a very unique place in any retirement plan and yet I find that it is often undervalued. Misunderstandings and short-term thinking can result in poor use of this very powerful resource.

More than a third of American workers claim Social Security benefits at 62, which is the earliest entitlement age, and also when they will receive the least benefit. This is referred to as early filing. With early filing the new lower-than-expected benefits are locked in for the remainder of one’s life. To highlight the difference, consider a person who at full retirement age of 67 would receive a benefit of $2,291 per month for life. If instead they file at age 62, their monthly benefit would be reduced to $1,487. This amounts to $9,648 less annually for life (or $17,844 instead of $27,492 each year), a significant decrease in retirement cash flow.

Claiming early Social Security benefits can be further reduced if you continue to work between ages 62 and your full retirement age. Early Social Security benefits will be dramatically reduced — up to a dollar for every $2 in earned income if your earnings exceed annual limits (usually the limits are around $19K of earnings though it changes each year).

There is a breakeven point for those thinking to file early. If, for some reason, you expect to die early and without a dependent spouse, then considering early Social Security benefits should be part of your planning.
Finally, many early Social Security claimants assume that Social Security is not taxed. In fact, taxation of Social Security benefits isn’t determined by a person’s age, but instead by income level. For example, if a married couple files jointly, and their income is above $44,000, then they will pay taxes on 85% of their Social Security benefits. On the other hand, if they earn less than that amount, they only pay tax on 50% of their Social Security benefits.

Always consider each available resource fully (including social security) to create the best support for your ideal retirement.

Edi Alvarez, CFP®

When does it make sense to payoff your mortgage before retirement?

It is relatively easy to make paying off your mortgage a goal, largely because you think it will “feel good” or because you imagine that it will be “liberating” to throw a mortgage burning party. But be careful that you are not mixing a critical financial decision with an emotional reaction. It may seem illogical, but there are many reasons why it is sometimes a better financial decision not to pay off your mortgage. That said, there are also some very good reasons for paying off your mortgage prior to retirement. The balance is often tipped by the amount the client spends on their lifestyle budget, the amount they have saved in available non-home assets, their tax liability, the source of the money used to pay off the mortgage and what they have decided to do for unexpected expenses.

For most of our clients, a mortgage on their principal residence is a low-rate loan that can be used (since 1997) to reduced tax liability (usual tax refunds drop the effective mortgage interest rate by as much as 1-3% for our clients). A mortgage repayment is stretched out (amortized) over a long period of time (15 or 30 years are common) with most of the interest paid during the first 2/3rds of the amortized period. When combined with inflation and a healthy appreciation in real estate valuations, a mortgage provides the buyer an opportunity to expense a very low cost loan while building equity in the home with money that would otherwise (at least in part) go toward rent. A mortgage loan can also be used to maximize and grow savings pre-retirement, obviously freeing clients to use these savings later while in retirement. The argument can also be made that a diversified portfolio started with assets that might have been used to pay off a mortgage (though not guaranteed) can yield a rolling average of 6-9% (with a margin of safety) and provide assets that grow above the mortgage rate and that are available for use outside of the home asset.

Many of our clients will have reduced or no earned corporate income during their retirement years, and plan to rely primarily on portfolio, pension, and social security to support them for 30-40 years. During this time they might have lower taxable income, but that is only true if their lifestyle expenses are low enough (something that is difficult to do in the Bay Area). If not, they might increase their taxable income to support their lifestyle and would benefit from available tax deductions (including mortgage interest). Most of our clients would like to remain in their homes throughout retirement, but this adds a further complication if they do not have enough non-home assets to support their annual budget. We find that home owners are surprised that they can’t tap most of their home equity (at reasonable costs) until they sell their home.

Paying off a mortgage is sometimes worth considering when the client has sufficient assets to support retirement outside of (i.e., above and beyond) their home. As an example, consider someone with a lifestyle expense in retirement of $100K annually (after social security). We can roughly estimate that they will need about $3M in portfolio assets to support their lifestyle and to ensure that they will not be forced to sell their home to support themselves. This $3M is only an estimate since it may not be sufficient if there is no supporting plan to cover unexpected expenses. But assuming there is sufficient savings and buffer, paying off the mortgage becomes a viable option which would reduce lifestyle budget (since there should be no mortgage payments) and tax liability.

Since several clients would like to hear scenarios that highlight the advantages of paying off their mortgage prior to retirement I’ve outlined two below:

1)  When a client plans to live in a mortgaged home until they need care, have low lifestyle expenses AND enough money outside of their home asset to support their lifestyle budget, including maintenance of their home. In this situation (particularly when their tax rate will not benefit greatly from remaining Schedule A deductions) the reduced expense derived from not paying a mortgage provides measurable benefit and real financial freedom. In addition, leaving a home with little or no mortgage is popular with those who wish to provide a legacy. However, clients have to be prepared for a potential increase in taxes in retirement particularly if they need to draw more from their portfolios. There is also the possibility that they may need to sell their home to unlock equity to cover unexpected expenses.

2)  Another scenario that encourages paying off the mortgage pre-retirement applies to clients with a low taxable income, sufficient non-home assets to support their lifestyle expenses and a sudden influx of cash to cover their mortgage (this cash must be more than the amount they can contribute in a tax advantageous manner and not needed to support their lifestyle).

It has been clearly demonstrated that anyone with a fully diversified portfolio benefits most from maximizing tax-advantaged savings prior to retirement. Usage of funds that could be contributed to these types of accounts to pay off a mortgage often results in too much home and not enough cash (house rich, cash poor, as the saying goes). This is particularly the case in areas where home appreciation is high and home equity grows, but can’t be accessed cost effectively. A misconception is that a large mortgage is the best way to reduce taxes because you can minimize them through Schedule A deductions. This is patently not true. The best way to minimize your taxes is through tax-deferred savings, not deductions. Do note that in retirement, neither tax deferral nor the option to obtain a mortgage at a reasonable rate may be available.

Each person needs to consider the best way to manage their mortgage payments in retirement. In this article, I have sought to help you recognize some of the key components that factor into whether it makes sense to pay off your mortgage prior to retirement. It is important that you realize that there is no single answer for everyone and that we must balance your budget, taxable income, amortization period and plan to cover contingencies during retirement before making this decision.

Edi Alvarez, CFP®

Retirement Plans for the Self-Employed – An introduction to reducing taxes by increasing retirement savings

The self-employed small business owner has at least three ways to save for retirement while saving on current taxes. The best known is the simplified employee pension plan (SEP). Not quite as well known, is the individual 401K-profit sharing plan (401K-PSP). And definitely least known is the Defined Benefit (DB) plan. Your choice should not be based on familiarity but on your retirement needs, current cash flow, and tax liability. Without planning the choices are limited to a SEP IRA or other IRAs. SEPIRAs can be created any time prior to tax filing but the contributions can only be as much as 20-25% of net earnings from self-employment (up to $52K).

A 401K-PSP, on the other hand, must be created in the same year (meaning that if it is used for 2014 contributions it must be created before Dec 31 of 2014). Ideally the contributions are made by December 31st for employee deferred compensation but employer contributions are made later, prior to tax filing. Employee deferral limits this year are $17.5K (plus an additional $5.5K after 50) or to the maximum earned, whichever is less. Profit sharing contributions can top up to $52K (plus an additional $5.5K after 50). Tax filings for the plan are required once the total assets exceed $250K. For most small business owners the 401K-PSP allows for higher annual contributions (than the SEP) and therefore lower tax liability.

DB plans are the least used by self-employed and yet the most powerful at reducing tax liability by allowing very high tax-deferred contributions. A business must have sufficient profit and cash flow to take full advantage of this type of plan. DB plans, like 401k, must be established in the same year and have specific requirements including annual tax filings. These types of plans are not limited by the fixed maximum contribution of $52K but instead on annually calculated contributions based on a future benefit. The maximum annual benefit is up to $210K this year. DB plans provide the highest contribution amounts particularly when combined with a 401K-PSP.

The best type of retirement savings plan for you, as a self-employed individual, is partially dependent on your business’s current and projected cash flow. Ideally you will match the features in all available plans with your retirement needs, selecting the plan that maximizes your retirement savings while reducing your current tax liability.

The key is to plan ahead with someone that knows the self-employed plan options and your personal and business finances. Working together you can provide for your future while reducing your tax liability today.

Edi Alvarez, CFP®

Social Security – an under appreciated but invaluable part of your retirement plan

Retirement planning entails finding ways to cover expenses when we ultimately cease or reduce our working income. The goal is to ensure that we don’t outlive our assets, regardless of our longevity.

To the surprise of many, one of the most valuable (yet under rated) tools to fund retirement is Social Security. Clients often ask about ways to bolster their retirement income; such as, maximizing their investments, reverse mortgages and annuities. They seldom consider how to maximize their Social Security benefits.

We pay for Social Security and Medicare through payroll taxes with the employer paying half of this expense and the employee, often grudgingly, paying the other half. In particular, I detect a sense of being “over taxed” by those who are self-employed and must therefore bear the full brunt of the Social Security tax. Some make it a goal to reduce their profit or earnings so that they can lower this tax, sometimes entirely avoiding paying any social security tax. And yet the very best inflation protected guaranteed income during retirement is Social Security. If you don’t pay the tax you don’t collect the retirement benefit.

I will outline a few interesting facts to help you understand aspects of Social Security that we consider when creating retirement projections.

Although you must have 10 years of Social Security taxed earnings to qualify for benefits the Social Security Administration actually uses the highest 35 years of earnings (any missing years are zeroed) to calculate your retirement benefit. To earn the maximum retirement benefit you would need to pay social security tax at the highest level allowed each year for 35 years. Each year the maximum social security taxable earnings changes. In 2014 it is $117K.

The earliest age you can begin to collect Social Security is 62 while the Full Retirement Age (FRA) is now between 66 and 67, dependent on your birth year. Unless in poor health, it is seldom advantageous to collect Social Security benefits before reaching FRA. Collecting Social Security prior to FRA will close the door on some options that can help maximize your Social Security income and should only be considered in unusual situations.

Many file for benefit at their FRA whereas others delay filing until sometime after FRA. Waiting until as late as age 70 to collect these benefits can significantly increase the Social Security payout for a lifetime.

One feature of Social Security that often surprises clients is the option to collect spousal benefits. Spousal benefits uses only your spouse’s work history to provide you with half of your spouse’s social security benefits. One way to use this option is (once you reach your FRA) to choose to delay filing for Social Security based on your own work history and instead claim half of your spouse’s benefits. Why would you do that? By collecting a reduced spousal benefit you can allow the benefit based on your own work history to continue to grow until up to age 70.

What are some considerations associated with receiving spousal benefits? The marriage must have lasted at least 10 years. You can claim based on your ex-spouse’s Social Security benefits so long as you’ve not remarried (or if you remarry after age 60). You can only claim a spousal benefit when you’ve both reached FRA. This feature works maximally for same age spouses since they can both claim spousal benefits on each other, therefore collecting Social Security while still allowing their own Social Security to grow until age 70.

One unpleasant feature of Social Security is called the Windfall Elimination Provision which can surprise workers who have worked for two employers where one was not subject to Social Security withholdings. The social security benefits are reduced even though the second earnings were subject to Social Security withholdings. We see the Windfall Elimination most often with teachers who also worked in other non-teaching positions.

So are Social Security benefits taxed? Yes. 85% of your Social Security earnings will be part of your retired taxable income. This can drop to 50% if the in-retirement AGI is low enough.

Your Social Security tax payment entitles you to guaranteed retirement income, an essential part of the retirement plan for most Americans. The important role Social Security plays in your retirement planning cannot be over stated. A sole conversation with Social Security Administration should not be enough. Considering that the Social Security handbook has over 2,700 rules in a thick manual called POMS (Program Operating Manual System) it should come as no surprise to you that the Social Security Administration can’t always provide the best information in relation to your own situation.

Take the time to determine what will be the best way to deploy your Social Security scenario since this retirement income will be both inflation protected and last you through your entire retired life.

Edi Alvarez, CFP®

ETNs (as ETFs) are they a good idea in your portfolio?

ETNs (as ETFs) are they a good idea in your portfolio?

Unlike an exchange-traded fund (ETF), an ETN (exchange-traded note) is your uncollateralized loan to investment banks. The banks promise exposure to an index’s return, minus fees. The draw is that, many (but not all) ETNs are taxed like stocks, regardless of the ETN’s true exposure not as ordinary income. These benefits could be a godsend for a hard-to-implement, tax-unfriendly strategy. You might think that you can have your cake and eat it, too.  Did we learn nothing from the bail out?

In fact, ETNs are dangerous tools in the hands of ‘professionals’ and a disaster for the unsuspecting public. They are one of the easiest ways individual investors and advisors unwittingly enter into contract relationships with vastly more sophisticated investment banks. It is hard to believe that in the midst of ‘financial regulation’ that ETNs (unlike mutual funds and most exchange-traded funds) are not registered under the Investment Company Act of 1940, or the ’40 Act, which obliges funds to have a board of directors with fiduciary responsibility and to standardize their disclosures. ETNs, on the other hand, are weakly standardized contracts. Where an ETN investor should fear what s/he doesn’t know, s/he instead is gulled into thinking s/he understands the risks and costs s/he bears.  If you can’t get yourself to read the prospectus carefully and analyse the fee structure caveat emptor.

The ETN is a fantastic deal for banks. An ETN can’t help but be fabulously profitable to its issuer. Why? They’re dirt-cheap to run. They’re an extremely cheap source of funding. More important, this funding becomes more valuable the bleaker an investment bank’s health – they can have their cake and eat it too! Finally, investors pay hefty fees for the privilege of offering this benefit. Believe it or not this isn’t enough for some issuers. They’ve inserted egregious features in the terms of many ETNs. The worst appear to insert a fee calculation that shifts even more risk to the investor, earning banks fatter margins when their ETNs suddenly drop in value (examples include DJP and GSP but there are many more).

The above fees scratch the surface. Other examples of investor unfriendliness follow:  UBS’s ETRACS (AAVX and BBVX etc) have a 4% levy on top of the 1.35% fee called event risk hedge cost.  Barclays’ iPath (BCM, etc) add 0.1% fee futures execution cost.  Also an additional 0.5% index calculation fee charged for Credit Suisse’s Liquid Beta (CSLS, CSMA, etc).

When many players in the industry behave in ways that signal they can’t be trusted, it raises questions about all ETNs. What a shame. The best ETNs could be useful tools, fulfilling their promise of tax efficiency and perfect tracking but none of these do.

The ETN product creators have gotten away with such investor-unfriendly behavior by free-riding the goodwill conventional ETFs have created as simple, low-cost, transparent, tax-efficient products. Understandably, many investors have taken for granted that the ETNs’ headline fees are calculated just like expense ratios, that “gotcha” fees are not facts of life. Given how publicly accessible ETNs are I recommend that most stay away from them.

*Edi Alvarez, CFP®


*The above is my opinion based on readings and triggered by an excellent article in Seeking Alpha by By Samuel Lee  “Exchange-Traded Notes Are Worse Products Than You Think” March 23, 2012.

2012 Social Security Rate Update

Annually SSI and Social Security payments are increased by the Consumer Price Index (CPI).  The CPI was just announced at 3.6% and this increase will translate to a similar increase for 55 million SSI (disabled) and SS (retired) recipients starting on December 30th.

Don’t be too quick to spend it! We expect an increase in Medicare premiums to be announced soon.  Even so, drug premiums are not expected to increase (Part D) and for many their out of pocket costs have decreased with the new donut hole coverage.  We caution that medical costs have risen and can be expected to translate into a rate increase for Medicare premiums.  Your specific situation will dictate if this rate increase translates to available cash.

On that note – October 15th started open enrollment for Medicare.  Make your annual Medicare selection before December 7th (

Although it may turn out to be good news for those already retired, it also  means that workers can expect an increase in their payroll taxes.  The ceiling for social security taxes will rise from $106.8K to $110K.

Currently 161 million workers contribute to Social Security taxes while 63 million receive SSI or Social Security income.

We’ll keep you posted and let us know if we can be of assistance.

Edi Alvarez, CFP®


Kaiser Permanente Physician Retirement

Kaiser Permanente Physician Retirement Package

After a long career, retiring physicians employed at Kaiser are faced with a Retirement Package that presents excellent opportunities and multiple planning pitfalls. Giving yourself and your adviser sufficient time to plan each component will yield the greatest return for your situation. Make sure that your retirement plan supports your goals and addresses each phase in retirement while reducing your tax burden. Start early!

The first component of the Kaiser Retirement Package is based on the number of years of credited service and the average of your highest paid three consecutive annual earning (base+bonus) years. For most long-term Kaiser doctors, this is their largest retirement resource that can be in the range of $200,000/year (amount does depend on the specific situation). Although HR will calculate this value for you there are many critical decisions that you and your adviser will need to address. Some decisions such as your payout structure will need to be based on your goals, estate wishes and your tax situation. They will require that you make life-long decisions on how you will receive these retirement benefits. Will it be for Life, Joint & Survivor, Period Certain or Installment? – These are not generic or trivial questions.

The second component in Kaiser’s Retirement package for physicians is the Defined Contribution plan that will also be calculated for you but will require your input – particularly on how you wish it distributed. Do you want it as a lump sum, an installment or defer until you are 70.5? For tax reasons in particular, it is critical that this decision be made as early as possible (ideally 5 years before you plan to retire). Often this component of the Kaiser Retirement package generates about $30,000 per year (this amount does depend on your specific situation). Don’t forget that this amount will be further supplemented by social security.

The third component of Kaiser’s physician retirement package is a Salary Deferral employee funded or 401K plan. Your annual contributions, of tax deferred dollars ($16,500 limit in 2009), properly allocated and rebalanced will grow to supplement the first two components of the Kaiser Permanente Retirement Package. With these three components Kaiser physicians can retire at close to pre-retirement salary levels.

The final piece of the Kaiser Retirement Plan provides benefits such as health care, dental and insurance benefits. These should be reviewed carefully with your adviser to ensure that they match your lifestyle and will support all of your retirement needs.

Edi Alvarez, CFP®