Retirement Planning

A reader writes in to ask:

“It seems to me that most personal finance discussions overlook divorced people. For example, as a divorcee, I have different tax planning and retirement planning considerations than other people. Would you mind writing an article discussing how Social Security benefits work for people who have been divorced?”

There are two types of benefits that can be claimed based on an ex-spouse’s earnings record:

1. Divorced spouse benefits, or
2. Surviving divorced spouse benefits.

The rules for both types of benefits are actually pretty similar to those for still-married couples.

Qualifying for Divorced Spouse Benefits

To qualify for spousal benefits on behalf of an ex-spouse’s earnings record, you must:

• Have been married for at least 10 years,
• Be age 62 or older, and
• Not currently be married.

In addition, either a) your ex-spouse must have already claimed his/her own retirement (or disability) benefit, or b) he/she must be eligible to claim such a benefit and you have been divorced for at least 2 years.

For the most part, divorced spouse benefits are calculated the same way as regular spousal benefits. That is, if you claim at full retirement age, your benefit will be equal to 50% of your ex-spouse’s primary insurance amount (i.e., the amount of retirement benefits he/she would receive if he/she claimed at full retirement age). Also like regular spousal benefits:

• If you claim prior to your FRA, your divorced spouse benefit will be reduced, and
• You do not get any additional benefit for waiting beyond full retirement age.

Important note: If you claim divorced spouse benefits prior to full retirement age, you will be deemed to have filed for your own retirement benefit as well. If, however, you wait until full retirement age to claim divorced spouse benefits, it will not be treated as filing for your own benefit — thereby allowing you to receive divorced spouse benefits for a few years while you allow your own retirement benefit to grow until age 70.

Qualifying for Surviving Divorced Spouse Benefits

If your ex-spouse has passed away, you may be eligible for surviving divorced spouse benefits on his or her behalf. In order to qualify:

• You must have been married for at least 10 years,
• You must be age 60 or older (or disabled and at least age 50),
• You must not currently be married,
• Your ex-spouse must be deceased, and
• Your ex-spouse must have been “fully insured” at the time of his/her death.

In general, surviving divorced spouse benefits are calculated the same way as regular surviving spouse benefits. That is, if you have reached full retirement age by the time you claim surviving divorced spouse benefits, your benefit will be 100% of your deceased ex-spouse’s benefit. If you claim surviving divorced spouse benefits prior to FRA, the benefit you receive will be reduced.

Important note: If the (now deceased) ex-spouse claimed benefits earlier or later than full retirement age, your surviving divorced spouse benefits will be based on the benefit that the deceased ex-spouse was receiving rather than on his/her primary insurance amount.

If You’ve Remarried

If you get remarried, you will not be eligible for benefits on your prior spouse’s record — unless your new spouse dies or you get divorced (that is, divorced from your second spouse), in which case you will again be eligible for benefits on your first spouse’s record. If you second marriage also lasted 10 years, you can claim benefits on behalf of either ex-spouse.

Exception to the rule: For surviving divorced spouse benefits, if your remarriage occurs after age 60 (or after age 50 if you’re disabled), it will not prevent you from claiming benefits on behalf of your prior spouse.

How About An Example?

Anne is married to Bob for 15 years. Then they get divorced, and Anne marries Christopher. After 15 years of marriage to Christopher, they too get divorced. When Anne reaches age 62, she can claim spousal benefits on behalf of either spouse. Because Bob made significantly more than Christopher over the course of his career, Anne chooses to claim spousal benefits on behalf of Bob.

A few years later, Christopher dies. Anne is now eligible for surviving divorced spouse benefits on his behalf. Despite Christopher’s lower earnings, surviving divorced spouse benefits on his behalf are greater than divorced spouse benefits on Bob’s behalf (because divorced spouse benefits are based on 50% of the ex-spouse’s benefit, whereas surviving divorced spouse benefits are based on 100% of the deceased ex-spouse’s benefit). So Anne switches to claiming surviving divorced spouse benefits on Christopher’s behalf.

A few years later, Bob dies too. Anne can now switch to receiving surviving divorced spouse benefits on Bob’s behalf (which, because of Bob’s higher earnings, should be greater than the surviving divorced spouse benefits on Christopher’s behalf that Anne had been receiving).

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January 2, 2012 3 comments

I sometimes receive emails from investors describing themselves as “behind schedule” with regard to retirement savings. They’re nearing the age at which they’d like to retire, but their portfolios just aren’t where they’d need to be to get the job done.

The truth is, if you’re in such a situation, there are things you can do to improve your chances of retiring comfortably, but they’re not magic bullets — they involve sacrifices and have imperfect success rates. Nor are they top secret tips — these are the same types of things we discuss here on the blog all the time.

Retire Later

Whether it’s sticking it out for an extra couple years at your current job or picking up part-time work in a more enjoyable field after leaving your job, retiring later is often the highest-impact thing you can do for your retirement finances. Each additional year of work is one more year to accumulate savings and one fewer year of spending from your savings.

Improve the Return from Your Investments

Many investors who find themselves behind schedule with their savings attempt to make up for lost time by ratcheting their stock allocation upward. Sometimes it works. Other times it backfires.

Rather than crossing your fingers and taking on more risk, my best suggestion for improving returns is to cut costs. While even this is not a sure thing, low-cost index funds (or ETFs) tend to outperform the majority of actively managed funds, and I have yet to hear of anyone finding a better predictor of mutual fund performance (within a given asset class) than fund expense ratios.

Annuitize Part of Your Portfolio (by Delaying Social Security)

Finally, the safest way to increase the amount you can spend from your portfolio per year is to annuitize a part of that portfolio via an immediate inflation-adjusted lifetime annuity. In exchange for giving up liquidity and the ability to leave the money to your heirs when you die, such annuities offer a higher level of income than you can safely take from a typical stock/bond portfolio.

Remember though, that delaying Social Security is akin to buying just such an annuity — one that’s a significantly better deal than what you could actually buy from an insurance company. So before using a part of your portfolio to purchase an actual annuity, it usually makes sense to use that part of your portfolio to satisfy your regular spending needs while you delay claiming Social Security benefits for as long as possible.

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• How to calculate how much you’ll need saved before you can retire,
• How to minimize the risk of outliving your money,
• How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
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December 7, 2011 20 comments

Justine writes in to ask,

“I started taking Social Security as soon as I was eligible — age 62. The more I read though, the less sure I am that claiming early was the right choice. I recently read an article stating that at age 70 you can withdraw your application, repay all the benefits you’ve received, and they’ll treat it as if you didn’t claim benefits until age 70. Is that really possible? I can’t find anything about it on the Social Security website.”

It was possible. In December of 2010 though, the Social Security Administration changed the rules to prevent people from using this option to get a large, interest-free loan from the government.

However, there still might be some things you can do to increase the amount of your monthly benefit if you’ve filed for Social Security benefits early and since changed your mind.

12-Month Do-Over

The change in the rules didn’t completely eliminate the ability to withdraw your application and pay back benefits received. Rather, it limited the do-over option in two ways:

1. It’s now only available once per lifetime, and
2. It’s now only available to people who have only been entitled to benefits for less than 12 months. (Note: You’re not “entitled to benefits” until you actually apply for benefits.)

Example: Beth files for benefits on her 64th birthday. Nine months later, she changes her mind and decides she’d rather wait until age 70. By filing Form SSA-521 and paying back all the benefits she’s received so far, she can essentially undo her application, thereby allowing her Social Security benefit to grow until age 70.

I should warn you though: From what I’ve heard from readers, the withdrawal of application process is not as easy as that one-page form makes it look — reasons being that:

1. Many SSA employees are not particularly familiar with the process, and
2. There can be tax ramifications if you’re paying back any benefits that you received in a prior year.

Suspend Benefits at Full Retirement Age

If you’ve been receiving benefits for 12 months or more, it’s not possible to pay back your benefits and start over. You can, however, suspend benefits once you reach full retirement age and choose not to start them again until age 70.

Example: Greg begins claiming benefits at age 62. Three years later, he changes his mind and wishes he had waited. Once he reaches his full retirement age of 66, he can ask for his benefits to be suspended. If he waits until age 70 to start them again, he’ll earn 4 years’ worth of “delayed retirement credits,” which will help offset the fact that he originally claimed benefits prior to full retirement age.

Social Security Earnings Test

Finally, if you claim benefits early and change your mind after missing the 12-month do-over window but before reaching your full retirement age, there’s still one thing you can do that will help you offset the effect of claiming early: Work.

In years prior to full retirement age during which you work while claiming benefits, the Social Security earnings test will reduce your annual benefit by $1 for every $2 by which your annual earnings exceed a certain amount ($14,160 in 2011).

Then, after you reach full retirement age, your benefit will be recalculated to account for the the benefits you didn’t receive earlier. For example, if the earnings test reduced the total benefit you received by an amount equal to ten months of benefits, your benefit after full retirement age will be calculated as if you’d claimed ten months later than you actually did.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less See it on Amazon.

• How to calculate how much you’ll need saved before you can retire,
• How to minimize the risk of outliving your money,
• How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
• Click here to see the full list.

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November 28, 2011 0 comments

A reader writes in to ask,

“My sister is 63 and recently retired. She has a pension that pays her basic living expenses, and she has not yet started taking Social Security.

Last year she withdrew 4% from Vanguard Target Retirement 2015 Fund (VTXVX). But over the last year, the fund only earned a return of 1.48%. Since this is generally her sole source of “extra money” beyond her pension, my conclusion is that she should scale back on the 4% withdrawal due the lack of a “keep even” return.

But with less money in her hand I fear she will feel strapped. She loves her travel.”

SWR: Safe-ish Withdrawal Rates

The original studies showed that a 4% inflation-adjusted withdrawal rate was successful over most historical 30-year periods for a balanced stock/bond portfolio in the United States. But mostly safe in the past is a long way from completely safe in the future. In addition, your sister might live longer than 30 years. Both of those points would suggest that perhaps a withdrawal rate of less than 4% would be wise.

That said, one year of a slightly-negative real return (1.48% nominal return, minus 3.9% inflation over that period) isn’t necessarily a catastrophe.

Indeed, during the historical period on which the 4% guideline is based, there were plenty of years when the return of a balanced stock/bond portfolio would have been less than the amount withdrawn (and plenty of years when the real return would have been worse than -2.42%), yet the 4% guideline was still mostly safe.

In other words, it’s not typically one year of slightly-negative real returns that spells disaster for a 4% withdrawal rate. Rather, it’s a market collapse right at the beginning of the period or several years of slightly negative returns that you have to watch out for.

Is Portfolio Depletion a Problem?

For this particular investor though, I’m not sure that we need to be worried about portfolio depletion at all. She has a pension that pays all of her basic living expenses, so income from her portfolio will be used purely for discretionary spending.

And she hasn’t started claiming Social Security benefits yet, so if she keeps her discretionary spending constant throughout retirement, the amount she’ll need to withdraw from her portfolio each year will decrease after a few years once she starts claiming Social Security.

In addition, some experts argue in favor of intentionally front-loading discretionary spending in the early years of retirement when:

1. You’re most able to enjoy it, and
2. You’re most likely to be alive to enjoy it.

As you can see, this question doesn’t have a right or wrong answer. It’s a lifestyle decision. Different people would make different choices here, and either choice (cutting back or not) could be perfectly reasonable.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less See it on Amazon.

• How to calculate how much you’ll need saved before you can retire,
• How to minimize the risk of outliving your money,
• How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
• Click here to see the full list.

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November 23, 2011 3 comments

Carol writes in to ask,

“I’m 53 now, my husband is 56. We’re both hoping to retire shortly after 60. I enjoyed your series on Social Security and when to claim it, but I’m not even sure we can count on it to exist when we get to retirement, much less pay how much we’re currently being promised.

We’re currently planning as if we’ll get nothing and that anything we do end up getting will just be a bonus. Do you think this is wise, or is it just going to postpone our retirement unnecessarily?”

I get questions of this nature frequently, so I thought it might be helpful to share my thoughts. But to be clear, I’m not an expert here. I’m not an economist, and I’m not an expert on politics. This is just an “average joe” sort of opinion.

Are Changes Coming?

In 2010, for the first time since 1983, Social Security expenditures exceeded the program’s non-interest income. And a deficit is projected for 2011 as well. According to the Social Security Administration, without any legislative changes, the Social Security trust fund is expected to be depleted by 2036.

Again, I have no special expertise here, but to me, those numbers sure make it seem likely that cuts are coming in some way, at some point.

It’s Not Economics. It’s Politics.

On the other hand, as GOP candidate Rick Perry’s recent difficulties have shown us, Social Security is still very popular with both parties. And proposing changes to it is politically dangerous.

I think common sense tells us that the more severely a proposed cut would affect people who are reliant on Social Security, the less politically viable that cut would be. In other words, if I had to make a guess, I’d guess that changes would focus more heavily on:

• People further from retirement, and
• People with higher incomes.

But will it focus on people who are currently under 60? Under 50? Under 40? I have no idea. Ditto for income — there’s just no way to know what changes to the program will look like. But I do think that the younger you are and the higher your income, the more risk there is that you’ll receive less than what the current system would promise.

It Depends on Your Risk Tolerance

Finally, in addition to your age and income, there’s a third factor at play: Your risk tolerance.

I’m not talking about the “tolerance for portfolio volatility” sort of risk tolerance. I’m talking about your tolerance for having to make real sacrifices. How much of a problem will it be if your income ends up being less than you’d planned on? Are there expenses you can easily cut? Can you go back to work if necessary?

The more flexibility you have with your spending, and the more ability you have to increase your income if necessary, the less danger there is in betting that Social Security will be there, in its current form, when you reach the age at which you could claim benefits.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less See it on Amazon.

• How to calculate how much you’ll need saved before you can retire,
• How to minimize the risk of outliving your money,
• How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
• Click here to see the full list.

A Testimonial from a Reader on Amazon:

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September 26, 2011 8 comments