immediate annuities – Jeff Dragon

Contrary to popular belief, the Social Security System actually makes money….sometimes. The only things the trust fund assets are allowed to invest in is treasury securities which they refer to as “interest bearing special issue” bonds. So when interest rates go down, the value of these bonds and notes go up therefore raising the value of the Social Security trust fund. It has happened fairly often in the 10 years or so which typically adds more time to the D-Day moment of when the benefits may have to lowered without some kind of legislative intervention. If the “special issue” bonds go up in value, it generally means the system can stay solvent for another year.

The Social Security Administration comes out with their annual report every year around this time and according to the newest report the above mentioned is exactly what’s happened. They give the prognosis for the program for the next 10 years and the next 75 years using a host of different economic numbers and stats like wage growth, population, mortality and immigration to try to get a handle on how many future claimants there will be.

The harbinger of bad things to come is what’s they call the “net-cash outflows” which means after everything that comes in and costs are taken out, the administration had to dip into the trust fund reserves to cover the shortfall. Recently they’ve been warning that this could happen but at the end of 2018, 3 billion of unexpected income made it profitable.

For 2019, the margin was a little slimmer. At the beginning of 2019, the total was $2,895,174, 945,000(almost 2.9 trillion) and it ended the year at $2, 897, 492, 826, 000 — $2.3 billion higher. So the system didn’t have to dip into reserves to cover the 64 million checks it issues to it’s recipients. However as positive as that is, it was the lowest gain since 1982. What about 2020?

Well I ‘m glad you asked. The Administration’s projections for 2020 not so rosy. A lot of people blame Social Security’s woes on the baby boomers but they might be just part of the problem. Here are some other contributors:

1) People are living longer. The system was never meant to pay people for 20 yrs after retirement. More 80 yrs olds out there than ever.

2) Immigration is down. Usually the people who are immigrants are typically younger and will pay into the system longer ergo supporting more of the older recipients.

3) Birth rates are down. People are not having as many babies as they did in the past. Younger workers pay into it and the older workers’ payments stay funded.

4) More high earners collecting more. These beneficiaries are getting a higher payout than the system has ever paid. And they usually live longer.

There’s a Connecticut democrat named John Larson who introduced legislation that would raise the payroll taxes from 6.2 % to 7.4% and added other rules about any beneficiary with income under $49,000 would not have to report their Social Security income. That was back in 2013– there’s been calls to vote on whether to vote on it(yes that’s really how it works in Congress) to no avail. Social Security has been a 3rd rail for politicians but with the upcoming shortfalls acting sooner than later would be advisable.

That’s all for now. More to come in this brave new decade.

Are you Social Security checks taxed? Absolutely! But wait a minute…how do you fund Social Security? Payroll taxes right? We pay 6.2% of payroll taxes into the system.

Social Security originated in the Roosevelt administration as a reaction to the Great Depression of the 1930’s as 50% of senior citizens were at the poverty level. The New Deal could create all the “shovel ready” projects possible but back in those days seniors were jazzercizing or eating fat free almond milk with their bran flakes so the health of our seniors of the 30’s wasn’t like it is now.

Originally the payroll taxes enacted through the Federal Insurance Contribution Act of 1939 or FICA as we know it today were much lower– around 4% but have been increased over time. The Reagan administration made portions of Social Security payments taxable and the current rates were created during the Clinton reign in 1993.

Below shows how your Social Security check is taxed:

If your income is low enough then you won’t pay any federal income tax on your benefit. But is that really something to shoot for? What if you income is high enough that you are required to pay the aforementioned taxes? Here’s some ideas to get a lower profile by changing your income to potentially not pay as much. Please note that Social Security calls this “provisional income” so tax free municipal bonds are NOT exempt: that income is counted in to your total income. Ever wonder why you have to write in your muni bond income on line 2 on a 1040? You don’t bring it over to the totals to the right do you? The IRS just wants to know as it effects how your Social Security pay is taxed.

One way is to build assets in a Roth IRA named for William Roth (Rep Del) who didn’t even get re-elected despite giving us this great savings vehicle. Roth IRA’s are funded with after tax money and are tax free forever. So Roth IRA income doesn’t count when taxing your Soc Sec check.
Another way to potentially change your income is the strategy of taking distributions out of your traditional IRA BEFORE you apply for Social Security benefits. You can use this income to live on and get the coveted delayed credits on your benefit when you take it the max age of 70. Then your Social Security benefit would be your main source of income.
Live somewhere that doesn’t tax your benefit. There are 13 states that tax your benefit- West Virginia, Colorado, Vermont, Connecticut, Rhode Island, Utah, Kansas, Minnesota, North Dakota, New Mexico, Missouri, Montana and Nebraska. Some states of course have NO income tax namely Alaska, Nevada, Florida, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee do tax dividends and interest to some degree so they can claim borderline admission to this group.
Also a method of changing your income to not pay as much income tax on your benefit is to use an annuity’s exclusion ratio. The exclusion ratio is a way to figure out what portion of the annuity income is excluded from tax. For example– if you are a 65 yr old man, your life expectancy according to the IRS and the census tables is 20 yrs. You invest $100,000 of taxable assets in an annuity. If you divide 20 by 12 you get 240 months. Divide the $100,000 by 240 and you get around $417.67 per month. This amount would not be taxable as it is looked at as a return of principal. However, were you do the aforementioned the actual payment from the insurance company would be $562 per month for the rest of your lifetime. The taxable portion would be $145. The exclusion ratio is determined by dividing the $417.62 by the $562 which equals a 74% exclusion ratio. Furthermore if the 65 yr old died before the 20 yr period is over then a beneficiary would get the payment stream. Eventually after the 20 yr period the “principal payments” would be all paid out and the whole amount would become taxable.
Similar to the above idea you can invest 25% of your retirement assets– maximum $125,000 — in an annuity that will pay you an income at a later date — 85 years old at the latest. The compelling reason for this is the Qualified Longevity Annuity Contract or QLAC’s is the amount invested is not figured into your required minimum distribution as required by IRS to spend down your retirement assets so they can recover all the income tax they let you defer while saving in retirement plans. As a result you have a lower RMD, thus lowering your taxable income and potentially the taxes you pay on your Social Security payments. For example, a 65 yr old has $500K in an IRA and is in a 30% tax bracket. If he invests the max $125,000 in a QLAC which will give him around $37, 673 at age 85 but lowers his taxes as his RMD would be smaller.
If you’re getting income you don’t need then gift it to a charity. These write-offs still exist.
If you’re getting interest income on a bond, stock or CD that you don’t spend then consider a deferred annuity where all the interest stays in the contract. If something comes up and you need some of the cash, you will pay taxes on withdrawals unless you use the 4th idea in this article with regard to the exclusion ratio.
Like the aforementioned if you are realizing interest or even dividend income that you are not using and don’t plan but want to leave this asset to your heirs then consider life insurance. Even if your health is not the greatest, there are ways to do this. It shelters the interest income and leaves a tax free legacy to your family or a cause you feel strongly about. The census tables have changed the rates to your benefit as people are living longer making these types of contracts richer than they were just 10 years ago.

Just a few ideas among friends. Always consult your tax person, CPA, etc to really find out what the actual numbers would look like for you. Realistically the personal finance algebra on these ideas are that tough but it’s always better to get a 2nd or 3rd opinion. Call or email me– I’m happy to help. So long til next time.