Maximizing Benefits

Taking Social Security Seriously
 

For almost two-thirds of Americans, Social Security is more than half of their income in retirement. For most of the rest, it is an important part of their retirement spending. Despite the concerns we've seen reported in the press, Social Security is on a sound financial footing. With changes that we expect to happen over the next decade, the program should be around for a long time. Each year Social Security sends out $700 billion in monthly checks.

Given its importance, Social Security should be an integral part of everyone's retirement planning. Knowing the options for receiving Social Security payments and when to sign up is often complicated, especially taking into account the different ages of spouses, marital histories and other factors. We look at 13 variables in planning strategies for Social Security payments.

Getting the strategy right can make a difference of hundreds of thousands of dollars in lifetime benefits; sometimes between a comfortable retirement and concern in later years. Benefits are calculated based on a complex formula that involves a 35-year work history. Examining that record and taking corrective action years before retirement, can be important for many people.

Investing for the Long Term

The Power of Postponement

Although recent experience has been discouraging, compounding investment returns over many years yields truly amazing numbers. Consider how money grows in an IRA for a young person who leaves the money alone until retirement.

The maximum contribution to an IRA is $5,000 a year for someone under age 50 (the money must come from earned income although parents can replace the contribution). Take a 20-year-old who earned and saved enough to put $5,000 in an IRA. Let's invest that money in a broad index that gets 10 percent returns, the average of stocks over the last century. After 50 years, the account would be worth $587,000 (this doesn't factor in inflation).

If he waits ten years, until age 30, the total at retirement would be less than half, $226,000. At 40, it would be $87,000; at 50, $34,000 and at 60, the total grows to $13,000.

These are average figures and the results could differ significantly. But this shows three things: how long you invest - whether for yourself, your children or grandchildren - is critical; the benefits of tax deferral make a huge difference; and achieving the broad stock market returns has been a great goal.

Gloom and Doom

Is it a Good Time to Invest in the Stock Market?

We never know when to buy stocks. The future is always murky. There are always plenty of things to worry about. And yet we know that over the long term --- 10 – 15 – 20 years --- stocks have almost always done very well. Over the long term, there are few other ways to keep with up with inflation and to accumulate any wealth.

The public attitude toward stocks has soured recently because stocks have not done well. Since the recent high in late April, the broad U.S. stock market is down 14 percent with much of that coming in several spectacular and scary drops. The most recent decade was the worst for the stock market in at least 100 years – worse even than during the Great Depression of the 1930s.

The world economy has suffered through a prolonged global downturn; the worst since the 1973-74 global recession and possibly since the 1930s. Recently Nobel Laureate Paul Krugman, in his column in the New York Times, predicted that we may be in the early stages of the third prolonged global Depression of the last 150 years.

Should we be depressed? Should we avoid stocks? Should we put our investment dollars under  the mattress, buy gold, party because the end is near?

Such gloom may be warranted but we like to look on the bright side. We would agree that the global economy was on the precipice in September 2008. It’s possible that we could have a serious relapse into recession but the odds favor a subdued but durable recovery.

Based on U.S. history and lessons from around the world, it’s likely that high unemployment will persist for at least several years. Even so, the U.S. recovery seems to be well established and likely to persist. The sluggish nature of the recovery, perversely, is likely to extend its duration as happened during the 1990s. But lacking a crystal ball, we cannot discount a second dip recession or some other massive economic mishap.

Why then are we so sanguine about the long-term prospects for stocks? For twelve years, the Dow Jones Industrial Average has hovered around 10,000. In inflation adjusted terms, the Dow has suffered a serious decline. By historical standards this is a long time for the stock market to stagnate. Meanwhile, Gross Domestic Product – the source of profits and ultimately the bedrock of stock valuation – has climbed by more than 60 percent.

While we don’t know when the stock market will break out of its funk, we are confident that it will eventually. Only long-term investors, those with horizons of five years or more, should normally participate in the stock market and over the long-term we see little to suggest that stocks will depart from their historic upward trend. If we are eventually to return to that trend, the very bad period that we’ve been stuck in for so long, actually augurs well for the future. 

We consider a key to participating relatively safely in any stock market uptrend is to craft a broadly diversified global portfolio, which is a mainstay or our investment approach.

A Brighter Future

The Recovery

After a tumultuous year in 2008 and a two-year recession, the global economy has begun to recover. People naturally are impatient with the slow pace and worried that the future is murky. No one knows whether the economy will slip into another recession or we’ll have a sluggish and jobless recovery. But it’s also possible that the recovery that has been sneaking up on us may turn out to be a strong and durable one.

What we do know for sure is that the stock market has not yet discounted a robust future. The Dow is no higher than it was 11 years ago. The market has not even climbed back to the levels of the dark period of last fall. If the historical trend of 10 percent annual growth had taken place over the last decade, the market should be more than double the current level. Over the last decade, we have had the worst stock market returns since reliable data became available in 1926. The market returns this decade are worse even than the ones during the Great Depression in the 1930s. The good news is that frequently the stock market does well following bad periods.

Value Based Financial Planning: An Hour to Change Your Life

It’s important to think about the big picture, but you can’t control the global economy. You can, however, control how you handle your personal financial situation and that’s what we do at Lexington Avenue Capital. It’s common not to have a plan for your financial future and little idea of exactly what your goals are. Most investment portfolios are a hodgepodge of accounts and securities. Frequently spouses fail to communicate on their finances. With value based financial planning, we try to bring order to this chaos. Everyone has unique needs and desires and resources. We help you clarify your goals, understand the trade offs and develop a financial road map to help you reach your most important objectives with the highest probabilities of success. While we want to help you define the big picture, we’ll handle the little details too so we can lower your stress and spare you some worries.

Taking Social Security Seriously

Frequently we work with people approaching retirement and we find that until they are actually on the threshold of filing for Social Security benefits, they don’t take it seriously. For most people, Social Security will be an important part of their income in retirement. Making sure that both spouses maximize benefits can be a complicated process and people should begin understanding the ramifications in their 50s. At that age, it’s still not too late to influence their individual Social Security formula, which is based on an adjusted 35-year earnings history. Recently we posted an article on our blog that goes into more detail about this. http://luxenberginfo2.blogspot.com/2009/12/taking-social-security-seriously.html

Year End Actions to Lower Taxes

Before year-end, it’s sometimes possible to take actions to lower taxes. One possibility given the big bear market, is to realize tax losses on securities. This can be done by selling individual securities or mutual funds, which may be lower in price than when they were purchased. These losses can offset capital gains on other securities or be saved for future years. Also, $3,000 of such losses can be used each year to offset ordinary income.

Roth IRAs in 2010 – One Time Only Conversion Opportunity

Soon we will be hearing a lot about the opportunity to convert retirement savings to Roth accounts in 2010. In one of the earlier tax bills, Congress approved a one-year opportunity for high bracket earners to convert portions or all of some retirement accounts into Roths. In doing so, people will have to accelerate the taxes due on these accounts but the payments can be divided between payments in 2011 and 2012. Once accounts are converted to Roths and held for five years, no taxes will be owed when the money is distributed. Also, unlike ordinary IRAs, there are no required distributions from Roths so they are a good estate planning vehicle. This shift is especially beneficial if one has money outside of retirement accounts to cover the taxes. This opportunity should be evaluated on an individual basis and we are geared up to help with that decision.

Lexington Avenue Capital Management

Unbiased, fee-only advisors working with individuals to help them develop sound financial strategies to reach their most important goals. Call us today for a complimentary Financial Road Map planning session or other financial questions.

Larry Luxenberg
luxenberg@lexingtonave.com
845-708-5306
www.lexingtonave.com

Investment Advisory Services provided through Partnervest Advisory Services LLC, a Registered Investment Advisor. Past performance is not indicative of future returns. Products with issuer guarantees carry the risk of issuer default.

Taking Social Security Seriously

A Key Decision for Retirement Planning

Most people who are younger than age 62 do not take Social Security seriously. For decades, the media has hammered into people that Social Security is going bankrupt and they cannot depend on it for retirement. Changes in the program will be necessary to keep it solvent but that has happened in the past and will likely happen again. The most recent major reforms occurred in 1983 and changes are needed again as life expectancies increase and major changes occur in Americans’ work habits.

Still, each year the Social Security Administration sends out more than $600 billion in benefits and nearly all Americans depend on the payments as one of their top four assets in retirement. Understanding the program is vitally important for most people.

One of the most important decisions people make about retirement is when to begin receiving Social Security benefits. And yet many people either do little analysis or only simple calculations. Delaying benefits can sometimes result in doubling monthly payments so it’s worth spending time on the decision. Many current retirees will collect more than $1 million in benefits from Social Security.

Ideally, Social Security should be part of your total retirement planning and should begin 10 to 15 years before full retirement age, now 66. Benefits are based on reported income during your top 35 working years. The formula is skewed toward average wage earners so people in their 50s can still influence benefits. In some cases people might want to take part-time jobs or even decline to use deductions and pay more taxes to maximize future benefits.

To the extent people analyze the decision, most use a simple break-even analysis that calculates when the higher payments received at a later age would surpass the smaller payments received for more years. This analysis ignores many factors and it’s potentially misleading. Frequently, people using this analysis underestimate their life expectancy. One quarter of the people who start Social Security at full retirement age will live into their 90s. A mistaken analysis will cost them dearly for decades.

The critical ages for influencing Social Security benefits are the decades of the 50s and 60s. By age 70, everything will be cast in stone. The Social Security formula is skewed toward modest earners, so people in their 50s can still greatly affect their Social Security benefits. Self employed professionals and spouses who left the workforce to raise children are among those who could benefit most from an analysis.

The analysis is complicated for one person but it is much more complicated for a couple, particularly when the ages and earnings histories diverge. Other factors to take into account are that benefits are cut between ages 62 and 66 if the person continues to work; one spouse can receive half the benefits of the other upon reaching full retirement age; and a survivor receives the highest benefits of either spouse. Social Security benefits are also taxed once the retiree reports income above a certain threshold. Those taxes now begin on couples with incomes about $32,000 and as much as 85 percent of the benefits are subject to taxation if their combined income is more than $44,000.

Each person or couple’s situation is unique but a proper analysis of when to apply for Social Security benefits should weigh at least 13 factors: age of each spouse, health, family history, joint life expectancy, previous marriages, current and future spending, retirement plans, tax bracket, reduction in benefits if they work before full retirement age, current assets, future sources of income such as pensions or inheritances, and life insurance. The Social Security website, www.socialsecurity.gov, provides a wealth of information and calculators where one can access his own earning history, but no one source of analysis takes everything into account. An accountant or financial advisor should be able to calculate different scenarios and advise on the risks and advantages of each. It is a complicated topic; long academic papers are being written on the subject.

In all cases it pays to begin taking your own benefits by 70 or spousal benefits at full retirement age. If you receive retirement benefits early, between 62 and 66 now, the benefits are permanently reduced by as much as 35 percent depending on year of birth. Between 66 and 70, your own benefits increase by 8 percent a year. Spousal benefits, which are a maximum of 50 percent of the higher earning spouse’s, cannot increase past full retirement age. However, survivor benefits do increase. Once the higher earning spouse dies, the survivor receives benefits equal to those of the higher earning spouse so it’s important to take joint life expectancies into account.

It’s not uncommon for people today to underestimate their life expectancy and outlive their assets. This is particularly important for women, who on average outlive their spouses and will end up relying on one Social Security check in their later years. Getting the best possible answers on Social Security could make a big difference in the comfort of one’s retirement.

Madoff and the Mattress

Choosing the Right Course

Two stories in recent weeks drove home to us how truly difficult a period this has been for investors. No matter how sophisticated or naïve you are, it has been tough to avoid disaster. This week Bernie Madoff drew a sentence of life in prison for running the biggest financial fraud in history. People gave their life savings to one of the most sophisticated investors in the world, a pillar of Wall Street, and it all vanished. One of his investors was a university that gave him a big chunk of its endowment. Among the contributors was the estate of a single woman who had lived frugally and invested in Blue Chip stocks for 70 years. A career civil servant, she had given the university more than $20 million dollars. A lifetime of successful investing was squandered in one poor decision.

At the other extreme was the classic person who did not trust financial institutions at all. Instead she stuffed all her spare money, almost $1 million, in a mattress. So secretive was the elderly woman, that even her grown daughter wasn’t aware of her savings habits. That backfired when the daughter decided in early June to surprise her mother and replace the lumpy mattress with a brand new one. When they realized the next day what had happened, they scoured the local garbage dump but with 2,500 tons of new garbage each day, the missing mattress was nowhere to be found.

There are risks everywhere and it’s difficult for even the most sophisticated investors to strike a proper balance. We draw on our three decades of institutional investment experience to spot the pitfalls and help you achieve your financial goals and dreams.

www.lexingtonave.com

Starting Young

The Power of Postponement

Many people have heard of the power of compounding. But it’s another thing to take a fresh look at the actual numbers. Consider how money can accumulate in an IRA for someone who starts young and leaves the money untapped until retirement.

Right now, the maximum contribution to an IRA is $5,000 a year for someone under age 50 (your income must be at least that high; the source of funds can’t be a gift). Let’s look at what would happen if by the time someone turned 20, they had saved and earned enough to put $5,000 in an IRA as a one time only contribution. Now let’s invest that money in a broad stock market index and earn the average return of stocks over the last century, ten percent. After 50 years, the account would be worth $587,000 (remember this doesn’t factor in inflation).

Now if that same person waits ten years, until he’s 30, to invest, the total at retirement would be less than half, $226,000. At 40, it would be cut to $87,000. At 50, it would be $34,000 and waiting till 60, the total would be only $13,000.

These are, of course, average figures and the results generally would differ significantly from this illustration. But this does make a number of important points. First, the length of time you invest – whether it’s for yourself, your children or your grandchildren – is critical. The benefits of tax deferral make a huge difference. And achieving the returns of the broad stock market has been a great goal.