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Myths and Facts about Social Security

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Myth: Social Security will provide most of the income you need in retirement.

Fact: It’s likely that Social Security will provide a smaller portion of retirement income than you expect.

There’s no doubt about it–Social Security is an important source of retirement income for most Americans. According to the Social Security Administration, more than nine out of ten individuals age 65 and older receive Social Security benefits.  But it may be unwise to rely too heavily on Social Security, because to keep the system solvent, some changes will have to be made to it. The younger and wealthier you are, the more likely these changes will affect you. But whether retirement is years away or just around the corner, keep in mind that Social Security was never meant to be the sole source of income for retirees. As President Dwight D. Eisenhower said, “The system is not intended as a substitute for private savings, pension plans, and insurance protection. It is, rather, intended as the foundation upon which these other forms of protection can be soundly built.”  No matter what the future holds for Social Security, focus on saving as much for retirement as possible.  You can do so by contributing to tax-deferred vehicles such as IRAs, 401(k)s, and other employer-sponsored plans, and by investing in stocks, bonds, and mutual funds. When combined with your future Social Security benefits, your retirement savings and pension benefits can help ensure that you’ll have enough income to see you through retirement.

Myth: Social Security is only a retirement program.

Fact: Social Security also offers disability and survivor’s benefits.

With all the focus on retirement benefits, it’s easy to overlook the fact that Social Security also offers protection against long-term disability. And when you receive retirement or disability benefits, your family members may be eligible to receive benefits, too.  Another valuable source of support for your family is Social Security survivor’s insurance. If you were to die, certain members of your family, including your spouse, children, and dependent parents, may be eligible for monthly survivor’s benefits that can help replace lost income. For specific information about the benefits you and your family members may receive, visit the SSA’s website at www.socialsecurity.gov, or call 800-772-1213 if you have questions.

Myth: If you earn money after you retire, you’ll lose your Social Security benefit.

Fact: Money you earn after you retire will only affect your Social Security benefit if you’re under full retirement age.

Once you reach full retirement age, you can earn as much as you want without affecting your Social Security retirement benefit. But if you’re under full retirement age, any income that you earn may affect the amount of benefit you receive:

• If you’re under full retirement age, $1 in benefits will be withheld for every $2 you earn above a certain annual limit. For 2014, that limit is $15,480.

• In the year you reach full retirement age, $1 in benefits will be withheld for every $3 you earn above a certain annual limit until the month you reach full retirement age. If you reach full retirement age in 2014, that limit is $41,400.

Even if your monthly benefit is reduced in the short term due to your earnings, you’ll receive a higher monthly benefit later. That’s because the SSA recalculates your benefit when you reach full retirement age, and omits the months in which your benefit was reduced.

Myth: Social Security benefits are not taxable.

Fact: You may have to pay taxes on your Social Security benefits if you have other income.

If the only income you had during the year was Social Security income, then your benefit generally isn’t taxable. But if you earned income during the year (either from a job or from self-employment) or had substantial investment income, then you might have to pay federal income tax on a portion of your benefit.  Up to 85% of your benefit may be taxable, depending on your tax filing status (e.g., single, married filing jointly) and the total amount of income you have. For more information on this subject, see IRS Publication 915,Social Security and Equivalent Railroad Retirement Benefits.

What Is Your Full Retirement Age?

If you were born in: Your full retirement age is:

1943-1954                  66

1955                           66 and 2 months

1956                           66 and 4 months

1957                           66 and 6 months

1958                           66 and 8 months

1959                           66 and 10 months

1960 and later            67

Note:  If you were born on January 1 of any year, refer to the previous year to determine your full retirement age.

The information contained in this material is being provided for general education purposes and with the understanding that it is not intended to be used or interpreted as specific legal, tax or investment advice. It does not address or account for your individual investor circumstances. Investment decisions should always be made based on your specific financial needs and objectives, goals, time horizon and risk tolerance.

The information contained in this communication, including attachments, may be provided to support the marketing of a particular product or service. You cannot rely on this to avoid tax penalties that may be imposed under the Internal Revenue Code. Consult your tax advisor or attorney regarding tax issues specific to your circumstances.

Neither Ameriprise Financial Services, Inc. nor any of its employees or representatives are authorized to give legal or tax advice. You are encouraged to seek the guidance of your own personal legal or tax counsel. Ameriprise Financial Services, Inc. Member FINRA and SIPC.

The information in this document is provided by a third party and has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial Services, Inc. While the publisher has been diligent in attempting to provide accurate information, the accuracy of the information cannot be guaranteed. Laws and regulations change frequently, and are subject to differing legal interpretations. Accordingly, neither the publisher nor any of its licensees or their distributees shall be liable for any loss or damage caused, or alleged to have been caused, by the use or reliance upon this service.

Retirement Income Shortfalls

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If you’re lucky, your expected income sources will be more than enough to fund even a lengthy retirement. But what if it looks like you’ll come up short? Don’t panic–there are probably steps that you can take to bridge the gap. A financial professional can help you figure out the best ways to do that, but here are a few suggestions:

  • Try to cut current expenses so you’ll have more money to save for retirement
  • Shift your assets to investments that have the potential to substantially outpace inflation (but keep in mind that investments that offer higher potential returns may involve greater risk of loss)
  • Lower your expectations for retirement so you won’t need as much money (no beach house on the Riviera, for example)
  • Work part-time during retirement for extra income
  • Consider delaying your retirement for a few years (or longer)

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Identify your sources of retirement income

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Once you have an idea of your retirement income needs, your next step is to assess how prepared you are to meet those needs. In other words, what sources of retirement income will be available to you? Your employer may offer a traditional pension that will pay you monthly benefits. In addition, you can likely count on Social Security to provide a portion of your retirement income. To get an estimate of your Social Security benefits, visit the Social Security Administration website (www.ssa.gov) and order a copy of your statement. Additional sources of retirement income may include a 401(k) or other retirement plan, IRAs, annuities, and other investments. The amount of income you receive from those sources will depend on the amount you invest, the rate of investment return, and other factors. Finally, if you plan to work during retirement, your job earnings will be another source of income.

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Decide when you'll retire

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To determine your total retirement needs, you can’t just estimate how much annual income you need. You also have to estimate how long you’ll be retired. Why? The longer your retirement, the more years of income you’ll need to fund it. The length of your retirement will depend partly on when you plan to retire. This important decision typically revolves around your personal goals and financial situation. For example, you may see yourself retiring at 50 to get the most out of your retirement. Maybe a booming stock market or a generous early retirement package will make that possible. Although it’s great to have the flexibility to choose when you’ll retire, it’s important to remember that retiring at 50 will end up costing you a lot more than retiring at 65.

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Project your retirement expenses

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Your annual income during retirement should be enough (or more than enough) to meet your retirement expenses. That’s why estimating those expenses is a big piece of the retirement planning puzzle. But you may have a hard time identifying all of your expenses and projecting how much you’ll be spending in each area, especially if retirement is still far off. To help you get started, here are some common retirement expenses:

  • Food and clothing
  • Housing: Rent or mortgage payments, property taxes, homeowners insurance, property upkeep and repairs
  • Utilities: Gas, electric, water, telephone, cable TV
  • Transportation: Car payments, auto insurance, gas, maintenance and repairs, public transportation
  • Insurance: Medical, dental, life, disability, long-term care
  • Health-care costs not covered by insurance: Deductibles, co-payments, prescription drugs
  • Taxes: Federal and state income tax, capital gains tax
  • Debts: Personal loans, business loans, credit card payments
  • Education: Children’s or grandchildren’s college expenses
  • Gifts: Charitable and personal
  • Savings and investments: Contributions to IRAs, annuities, and other investment accounts
  • Recreation: Travel, dining out, hobbies, leisure activities
  • Care for yourself, your parents, or others: Costs for a nursing home, home health aide, or other type of assisted living
  • Miscellaneous: Personal grooming, pets, club memberships

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Use your current income as a starting point

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It’s common to discuss desired annual retirement income as a percentage of your current income. Depending on who you’re talking to, that percentage could be anywhere from 60 to 90 percent, or even more.

The appeal of this approach lies in its simplicity, and the fact that there’s a fairly common-sense analysis underlying it: Your current income sustains your present lifestyle, so taking that income and reducing it by a specific percentage to reflect the fact that there will be certain expenses you’ll no longer be liable for (e.g., payroll taxes) will, theoretically, allow you to sustain your current lifestyle.

The problem with this approach is that it doesn’t account for your specific situation. If you intend to travel extensively in retirement, for example, you might easily need 100 percent (or more) of your current income to get by. It’s fine to use a percentage of your current income as a benchmark, but it’s worth going through all of your current expenses in detail, and really thinking about how those expenses will change over time as you transition into retirement.

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ESTIMATING YOUR RETIREMENT INCOME NEEDS

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You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you’ll need to fund your retirement.

That’s not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors.

Tax-Exempt Bond Fund (Municipal Bonds)

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What is a tax-exempt bond fund?

A tax-exempt bond fund (sometimes known as a municipal bond fund or muni bond fund) invests in tax-exempt municipal debt instruments issued by state governments or agencies, counties, cities, towns, or other political districts. From the shareholder’s point of view, the key feature associated with these funds is the advantageous income tax treatment they receive. This income tax treatment is generally the same as that enjoyed by holders of individual municipal bonds. Just as interest paid by municipal bonds is generally tax exempt at the federal level, so the income generated by municipal bond funds will also be free from federal income taxation.

Further, as with income produced by municipal bonds, the dividends paid by these funds may be exempt from state and local taxes as well. The dividends you received from a tax-exempt bond fund would likely avoid state income tax only in proportion to the percentage of total fund income attributable to securities issued in your home state. Any portion of income earned by securities issued outside your home state might be subject to state taxation.

The tax advantage means that, depending on your tax bracket, the after-tax return from a tax-exempt bond fund could actually be higher than that of a taxable bond fund.

Caution:  Keep in mind that while dividends derived from income may be tax exempt, dividends derived from capital gains are not.

Caution:  If you are subject to the alternative minimum tax (AMT), you must include interest income from certain municipal securities in calculating the tax unless the securities are specifically exempted from the AMT. For example, the American Recovery and Reinvestment Act of 2009 specifically exempts interest on private activity bonds issued in 2009 and 2010 from being included in AMT calculations.

What is a state tax-exempt bond fund?

As noted above, any state income tax advantage applies only to income from bonds issued in the taxpayer’s home state or local municipality. However, some tax-exempt bond funds, known as state tax-exempt bond funds or single-state muni bond funds, invest exclusively in debt instruments issued by a particular state. A California tax-exempt bond fund, for instance, holds only bonds issued by or within the state of California. For residents of the state that issues the bonds–in this case, California–income from the fund is free from both federal and state income tax; residents of other states receive the federal but not the state tax benefit.

If you live in a local municipality (for example, a city or town) that levies its own taxes, a portion of your fund income may avoid those taxes as well if some of the bonds held by the fund were issued directly by your municipality.

Tip:  There are state tax-exempt bond funds for almost every state in the United States.

When can it be used?

Tax-exempt bond funds may be suitable for somewhat conservative investors who want to invest in mutual funds without the volatility that may accompany stock funds and certain corporate bond funds. They are appropriate for investors seeking current income and for individuals in high tax brackets who want to minimize their income tax liability. Investors with more modest levels of income may not benefit as much from the tax treatment, however. The income they provide also can be used to help moderate volatility from other investments in a portfolio.

Strengths
Income tax benefits

The tax advantages are the greatest strength of tax-exempt municipal bond funds. Not only is the income generated by these funds free from federal taxation, but it may avoid state and local taxation in some cases as well. Investors may even enjoy triple tax-exempt treatment. This might occur, for instance, in the case of a New York City resident who would avoid federal, state, and city taxes on the portion of fund dividends representing income earned by New York City bonds. If you pick the right fund, these tax savings can significantly reduce your total tax bill. In general, the higher your tax bracket, the more attractive the tax benefits become.

Provides current income

Most bond funds seek to provide current income. However, these funds may provide a more reliable source of current income than most other bond funds. Even if you don’t need the extra income, you can still reinvest your dividends, or simply allow the income to help moderate the volatility of your portfolio

May carry lower risk than some other bond funds

Though it’s not impossible for state and local governments to default on bonds, the default rate on munis historically has been lower than that for corporate bonds (though past performance is no guarantee of what might happen in the future, of course). Because governments are generally able to raise taxes if necessary to pay their debts, muni bonds as a whole are considered a relatively conservative bond choice. And by investing in debt from a variety of issuers, a bond fund reduces the impact of possible default by a single governmental body.

Tradeoffs
Generally modest returns

The return on a given tax-exempt bond fund depends on several variables that affect municipal bond yields, including local economic factors and quality ratings assigned to specific securities. Because of their tax advantage, returns are generally expected to be lower than with other investments (though as noted above, the tax advantage also means that depending on an investor’s tax bracket, the net return could actually be higher than that of a taxable bond fund).

Susceptible to interest rate risk and inflation risk

When interest rates rise, bond prices fall. When interest rates go down, bond prices rise. Shares in a bond fund that you may have bought when interest rates were low can lose value as interest rates increase because the existing bonds in the portfolio aren’t as valuable as newer bonds that pay higher interest rates. (However, one advantage of having a bond fund is that the fund’s manager also can adjust the portfolio over time to take advantage of those higher-paying bonds.)

Inflation risk refers to the possibility that the return on your investments won’t keep pace with increasing price levels. As prices rise, the value of a dollar falls, resulting in a decreased ability to purchase goods and services. Bonds that offer a fixed interest rate assume this kind of risk. If the overall interest paid by the bonds in your fund is lower than the inflation rate, your investment dollars may not grow enough over the years to allow you to reach your financial goals. And if you rely on the fund for current income, those payments may lose purchasing power to inflation over time.

As with all bond funds, both tax-exempt and state tax-exempt bond funds never mature as an individual bond does. Therefore, they don’t offer the same assurance that your principal will be returned to you at some fixed future date. Before investing, carefully consider a fund’s investment objectives, risks, fees, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing, as you would with any mutual fund.

State tax-exempt funds offer less diversification

The trade-off for receiving a greater tax advantage from a single-state muni fund focused on your state is the greater risk involved in a more narrowly focused fund. Because the fund’s holdings are limited to the bonds of one state, it has less protection from the impact of local economic problems. For example, if a state is heavily dependent on an industry that experiences an economic downturn, its finances (and those of the cities and towns in it) could be at greater risk of struggling to meet debt payments. If your job might also be affected by the same circumstances, that would put you doubly at risk.

Also, some states may have legal requirements that make it more difficult for a governmental body to raise taxes, even to pay its debts. Though diversification alone can’t guarantee a profit or ensure against a loss, municipal funds that invest in bonds issued by multiple states may offer greater diversification and more diluted risk.

Three tips for Social Security

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  • Use the benefit calculators available on the Social Security website to estimate your future retirement, disability, and survivor’s benefits. Social Security was never intended to cover all of your financial needs, but understanding what benefits you might be entitled to can help you plan for the future.
  • Consider the impact on your Social Security benefits if you plan on taking time out of the workforce. Having years of no or low earnings may mean lower benefits, and can also affect your eligibility for disability coverage.
  • Check your earnings history regularly, and report any name changes right away to the SSA so that your earnings are recorded properly. If your name doesn’t match SSA records, any income tax refund can also be delayed.

Sources: *Fact Sheet: Social Security Is Important to Women, SSA Press Office; **Fast Facts & Figures About Social Security, 2011, SSA

Retirement benefits: a steady stream of lifetime income

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While Social Security retirement benefits are important for everyone, they are especially important for women. Because women generally live longer and tend to have lower lifetime earnings than men, they may be more dependent on Social Security benefits in retirement.*

Fortunately, you can count on two features of Social Security to help you provide for a long retirement. First, benefits last as long as you live; although you may exhaust other sources of retirement income, it’s impossible to outlive your Social Security retirement income. Second, Social Security benefits are subject to automatic cost-of-living adjustments that increase benefits when prices increase, an especially valuable feature when you have to rely on a fixed income for many years.

When you work and pay Social Security taxes, you earn credits that enable you to qualify for Social Security benefits. You can earn up to 4 credits per year, depending on the amount of income that you earn, and you’ll generally need 40 credits (10 years of work) to be insured for retirement benefits. Your monthly retirement benefit will be based on your lifetime earnings. However, if you don’t work outside the home or haven’t worked long enough to qualify for Social Security based on your own record (or have much lower earnings than your spouse), you may still be eligible based on your spouse’s record.