The Lange Money Hour: Where Smart Money Talks
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Getting the Most from Your Social Security and More
With Guest Dr. Laurence Kotlikoff
Jim Lange, CPA/Attorney
Guest: Dr. Laurence Kotlikoff
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
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- Introduction of Guest – Dr. Laurence Kotlikoff
- What Larry Covers in his Books
- Three Rules to Help Make Social Security Work for You
- Software to Help Make Retiring Easier
- When to File for Social Security and What Benefits to File For
- What if I Need to Collect Social Security at 62?
- Recap and the Benefits of Repaying and Reapplying for Social Security
- Delaying Social Security Collection and Roth IRA conversions
- What if Social Security Disappears?
- Withdrawal Rates and Wrap Up
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
David Bear: Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks. I’m David Bear with Jim Lange, CPA/Attorney and author of two bestselling books: Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again. As you approach retirement, decisions you make about taking Social Security will have long-term consequences. Every case is different, but making the right choices will greatly increase future financial security for you, your spouse and your heirs. To share insights for maximizing your benefits, we welcome nationally recognized Social Security expert, prolific author and Boston University Professor of Economics, Dr. Laurence Kotlikoff back to the show. An active columnist, his work appears in Financial Times, Bloomberg, Forbes, The Economist, Huffington Post and The PBS NewsHour. His latest book, The Clash of Generations: Saving Ourselves, Our Kids and Our Economy, is winning praise as did his 2008 publication, Spend ‘Til the End: The Revolutionary Guide to Raising Your Living Standard Today & When You Retire. In addition to his myriad academic accomplishments, Dr. Kotlikoff has created software that the Washington Post has called, “The deepest and most powerful financial planning engine.” He is also a financial consultant to numerous Fortune 500 companies. Today, he and Jim will cover topics and intricate questions about Social Security, a subject far more complex than most listeners realize. He is a knowledgeable, entertaining guest, so it’s sure to be an interesting and informative hour. And listeners, since our show is live, you can join the conversation. Call the KQV studios at (412) 333-9385 with your comments and questions. With that, I’ll say hello, Jim and welcome, Dr. Kotlikoff.
Jim Lange: Welcome, Larry.
Larry Kotlikoff: It’s a pleasure to be with you, Jim. Thanks for having me.
Jim: You know, before we even get started, I have a quick Larry Kotlikoff story. Larry has been on the show a couple of times, but one time he just gave me some wonderful insights on Social Security. I was writing my Roth IRA book and I wanted to do some work on the interrelationship between Roth IRAs and Social Security. So, I wrote a section in the book and I thought, “Boy, there’s nobody in the world that would be better to review this section than Larry Kotlikoff,” so I e-mailed it to him and I said, “Larry, if you could review this little section, I would sure appreciate it.” And he not only reviewed it, but he actually added about a page-and-a-half of his own thoughts that were relevant and it was right on and, of course, I included it in my book. When I published the book, my editor at the time was my mom, a retired journalism professor, and my mom was very liberal with the red pen. So, all throughout the manuscript, there were all kinds of red pen marks, comments, things that I did wrong, but for the page-and-a-half that Larry wrote, there wasn’t one red mark! And at the bottom of the page-and-a-half, she wrote “Very good!” So, in addition to all of his economic accolades and everything else, Larry was one of the few survivors of my mom’s editing. So, Larry, thank you again for that.
Larry: Well, thank your editor. That’s a fine story for me. Glad to hear that!
Jim: You did a great job. One of the problems with having Larry on the show, and we did promise a Social Security show and we’re certainly going to cover Social Security, is that’s really just one part of Larry’s expertise. It’s so broad and Spend ‘Til the End has so many very good, important financial tips and actions to take, I really recommend it. That’s Spend ‘Til the End by Larry Kotlikoff and the other book that he has that is more recent is probably more of a prescription for the country. Larry says our country is broker than broke and that book is The Clash of Generations: Saving Ourselves, Our Kids and Our Economy, which is really a fine book. After Larry paints this horrendously gloomy picture, he then gives a solution to our problems, and then says, “Well, probably, we’ll never get it together to solve these problems, so here is what the individual should do.” So, Larry, you are really prolific and have such great information.
Larry: Well, I got a little help. My co-author on both books is Scott Burns. He’s a noted financial columnist with the Dallas Morning News. He’s a fantastic guy and a fantastic thinker about financial issues, on personal and global and national levels.
Jim: Well, actually, the book has tremendous reviews and was very powerful, and I loved it. You know, the part that, frankly, I spent the most time on was the section that you actually said, “Okay, so we’re probably in real trouble. Here’s what you guys should do to defend yourselves.” And, hopefully, we’ll get to that. In fact, we WILL get to that tonight. But I don’t want to skip the issue of Social Security, particularly because we promised it, and because I think that there’s so much that people can do. There’s a lot of people, let’s say, listening who are in their early to mid-sixties and they’re thinking, “Boy, you know, I’ve been working all these years,” and let’s even keep it a simple case. They’re now retired and what they want to do is they want to make sure to get their Social Security because they don’t know what’s gonna happen to the country. They are a little bit worried and this way, you know, they don’t want to go into their savings if they can help it, or at least not for as much money as they would otherwise have. So, they want to take their Social Security. So, Larry, what would you tell somebody? Let’s start with a simple situation. Let’s call it a single person. What would you tell somebody who is in their early sixties and really wants to take Social Security starting now?
Larry: Well, I would say this is a very complicated system. It’s more complicated, really, than the federal income tax, and there are certain strategies for getting more benefits. There are basically three general rules. Rule one is to delay taking benefits when some of these benefits are going to rise dramatically if you wait. So, that’s rule number one. Rule number two is to make sure you take all the benefits that are available to you. A lot of people don’t realize that if you’re, for example, widowed, you can get a widow’s benefit. If you’re divorced and you were married for ten years or more, you can get a benefit based on your exes’ earnings record if you play your cards right. And the third rule is to make sure that doing the first rule doesn’t screw up doing the second rule. Because if you take your own retirement benefit at the wrong time, you’ll wipe out these other benefits that are available to you. So, I have a financial planning software company that has a software program called “Maximize My Social Security”, and for $40, people can find out what strategy, in terms of collecting which benefits at which time, will generate the highest lifetime benefits. So, I could go through some examples if that is a good idea for you? What do you think?
Jim: Before you do that, could you tell everybody how they could get a hold of that software? Now, very frankly, I have not examined that particular software, but I have looked at some of your other software at ESPlanner, and I think that that is brilliant. The one that I know is the one…which by the way, I would still recommend for anybody, particularly for people who like to kind of plot things out, especially since one of your suggestions is to get an idea where you’re going. The one I was thinking of is at www.esplanner.com, and the basic one, which is free, is www.esplanner.com/basic. Then, there’s a more advanced one, which is www.esplanner.com?
Larry: Yes. Sorry about the background noise, Jim. I’m just spinning into a quieter place in a second. But yeah, the place where our Social Security software is where you can buy it for $40, it’s called maximizemysocialsecurity.com. Just maximizemysocialsecurity.com, and for $40, you can get the right answer.
Jim: Well, again, you know, I haven’t looked at that software, but I will just tell you that every software and every…
Larry: And Jim, could you speak up a little bit? I’m having a really hard time hearing you.
Jim: Okay. I was gonna say that every piece of software and every book that you’ve written has been really excellent, so I imagine that this is too. But going back to our example, why don’t we just start with a simple example: a single person in his early sixties, not divorced, not widowed, let’s even say never married, obviously has an earnings record, and let’s say an average life expectancy. What general advice could you give him? Now, your general rule was to delay if you can if the benefit will increase. Is that what you would typically tell somebody in that situation who is single?
Larry: Well, somebody in that situation would be, in general, if they can explain their cash flow issues, they should wait until they’re seventy because taking benefits at 62 will produce benefits that are much lower over their lifetime than if they wait until seventy. Social Security provides a terrific incentive to waiting to collect. So, your benefits at seventy, adjusting for inflation, are 76% higher than at 62. So, for a single person who’s never been married, the basic story is try and wait until seventy and collect a much higher number for…you can live to 100, so 76% higher benefits for thirty years amounts to a huge amount. Now, if you’re married or divorced or widowed, things get much more complicated because you’ve got this other benefit. If you’re married, you can get a spousal benefit. If you’re divorced, you can get a spousal benefit if you were married for 10 or more years. And if you’re a widow, you can get a survivor benefit. So, then the question is: how can you get those benefits as well as getting your retirement benefits? And the story there is to sequence them. You want to basically try and double dip and get those benefits. What happens is, if you take them both at the same time, the retirement benefit will either fully or partially wipe out the other benefit. So, what you want to do is to try and take one of those benefits first. So, for example, if you’re a survivor, you may want to take your survivor benefit before your retirement benefit. Or, actually, for some people, it might be better to take their retirement benefit first and then take the survivor benefit because you will get the larger of the two. So, the survivor benefit can wipe out the retirement benefit if it’s bigger than the retirement benefit, but the retirement benefit can also wipe out the survivor benefit if the retirement benefit is bigger. So, you see the thing, the idea here is that you have to be careful. The ideal thing is to take one benefit first, and then let the other benefit grow because Social Security provides this huge return to the other benefit.
Jim: Yeah, that’s one of the things that I saw in your analysis that was so wonderful when we talked about both apply-and-suspend and the survivor’s benefit, and even if you were married ten years and had the divorce. The other thing that I always remember that you were saying was back when we were talking about the single person, I mentioned that I had kind of done some math, and depending on the interest rate that you use, that your “break even” point was 84 years old, and if you lived beyond 84, you were better off waiting. If you died before age 84, then you’d be better off taking it early, and then I remember your comment was, “Well, if you do it early and you die, you’re dead! It doesn’t matter. That’s not your problem. Your problem is living a long time and not receiving enough income in your older age.”
Larry: Yeah. From everything we know, you don’t need money in heaven! Heaven is supposed to be free, right? Heaven is supposed to be heaven, and it doesn’t require money. You don’t need to have rubles or dollars or shekels or yen or…
David: Of course, you do need a charge card if you go to the other place, I think!
Larry: Say again?
David: You need a charge card if you go to the other place, so…
Larry: Exactly! So, the real concern is living. That’s the real danger. It’s not dying. Dying is cheap, living is expensive. And so, you have to really value the insurance component of Social Security, which is gonna be a benefit coming to you right up to your maximum age of life. So, in our software, we fully incorporate that. We say, “Let’s figure out your benefits in a worst case scenario, which is you live to 100,” or some other…you know, you can set your own maximum age of life in the software, but the default value is 100.
And then, you know, if you take…a lot of people think that Social Security is just an issue for lower income people. It’s relatively more important for low-income people, but somebody who’s been earning the taxable maximum, if they do the typical thing that people have done in the past, which is the husband and wife both go and get their benefits at age 62, they’ll get about a…if they’re currently around 60, if they decide that they’re gonna take their benefits at 62, they’ll get about $1,400,000 in benefits. If they wait until…if they do the right thing and get a free spousal benefit for one of the two, and then wait until 70 for them both to take their retirement benefits, which, in the example that I have in my mind, in this case, where they’re both earning at the maximum taxable level for their entire careers, then their lifetime benefits go up from $1.4 million to about $1.8 million. So, there’s another $400,000 gain in lifetime benefits. Actually, sorry, it’s $1.2 million to about $1.6 million, so there’s about a $400,000 lifetime gain from doing the right thing.
So, a lot of people…for almost everybody, actually, Social Security is either the biggest asset that they’ve got apart from their house, or the second biggest financial asset, and figuring out how to maximize your benefits is very important. There are strategies. You know, the way that a couple that’s both 62 can get a free spousal benefit is that if they’re both pretty good earners, is to have one of them at full retirement age do something called “file and suspend.” They go in, they ask for their retirement benefit, but then they suspend its collection. That permits the other spouse to apply just for a spousal benefit, and not…when you close, you’re applying just for a spousal benefit. Their own retirement benefit isn’t being taken and therefore doesn’t wipe out their own spousal benefit. So, they can get what’s called a “full spousal benefit,” and that will equal half of their partner’s full retirement benefit.
So, if the full retirement benefit is, let’s say, $30,000 for a high earner, half of that’s $15,000. So, let’s say the wife collects $15,000 for four years between full retirement at age 66 and 70, and then switches to take her $30,000, well, maybe $30,000, $35,000 a year retirement benefit. That’s, in effect, $60,000: $15,000 for four years. $60,000 for free, compared to not doing that. So, meanwhile, her own retirement benefit is growing 8% a year. It doesn’t compound, but every year that she waits between 66 and 70, the benefit is 8% more. So, if you wait between 66 and 70, your benefits starting at 70 are four times eight, 32% higher than at age 66. So, you’re not losing anything by waiting. You’re getting this terrific gain from having a 32% higher benefit from age 70 though 100, but you’re also collecting a free spousal benefit. Now, both spouses can’t do this because if they both file-and-suspended, they would kind of wipe out their spousal benefit. They’d both be perceived by Social Security to be collecting both retirement and spousal benefits at the same time, and then you have one benefit zapping the other.
So, that’s where the complexity comes in. If the husband and wife were divorced, then they could both actually get a free spousal benefit because Social Security, in that case, allows them both to collect. So, Social Security actually has incentives for married people to get divorced. This couple that I’m talking about could pick up an extra $50,000 by getting divorced, living in sin and remarrying again at 70. And then, you’ve got other people that are living in sin right now who have big incentives to get married because of Social Security, because it only takes about a year for you to be married before your spouse that you’ve just married can collect a spousal benefit on your account, and then, if you kick off, that person can collect a survivor benefit on your account.
David: Before we take a break, do you have any words of wisdom for people who aren’t in the position of waiting? I mean, is there, you know, I mean, these days, people lose jobs and there are other issues. Is there anything that they can do?
Larry: Well, not everybody can wait, obviously, but if they have other assets like retirement account assets, 401(k) assets, IRA assets, using those to get by. You can also start your benefit at 62. Suppose you had a pension coming in at 65, and you started your own Social Security benefit at 62, well, when you get to full retirement age, which is currently 66, you can actually suspend your benefit. So, suppose your current benefit, or you started taking benefits at 62, you come to 66, you can suspend your benefit. You can’t do it before full retirement age, but at full retirement, you can suspend it, and you can start it up again at 70 and it will be 32% higher forever.
David: So, even if you’ve already taken it, you can still suspend it at 66?
Larry: Yeah, at any time after full retirement age. You do have to pay your Medicare premiums out of pocket. Otherwise, they will really screw you. They will not give you your benefit and not give you any increase in your benefit for those four years, or however long you suspend it. So, you want to make sure to pay your Medicare premium out of pocket. Otherwise, they will, in effect, reactivate your suspended benefit and not actually pay it to you.
David: So, you don’t get the credit for it?
Larry: Yeah, and I’m not sure they will tell you. Social Security is not to be trusted. The people are well meaning, but the system is too complicated for the people who are administrating it, the local staff of people. There are technical experts who really are brilliant in knowing the system, but they’re few and far between. So, you basically don’t want to listen to anything that Social Security says to you because it’s…you know, I’ve got people writing me all the time, e-mailing me all the time or calling me. They’re getting very bad advice because people just are not trained well enough. You’re talking about a system where the formula for a married person’s benefit involves ten mathematical functions, one of which is in four dimensions. Some of these mathematical functions of these ten functions are minimum and maximum functions, so they’re complicated animals, and nobody in Congress who passed or legislated this stuff has any idea of what they’ve done to people. They’ve made a basic retirement system that nobody can remotely understand on their own and that’s why we developed our software, to try and help people with this.
David: Well, on that note, let’s take a quick break.BREAK ONE
David: And welcome back to the Lange Money Hour with Jim Lange and Dr. Laurence Kotlikoff.
Jim: And before we get started, I just wanted to remind listeners of three resources that we have mentioned, all of which I recommend. One is Larry’s book, with Scott Burns, called Spend ‘Til the End. The second one, which is the more recent book, which is really more of a what’s wrong with the country and what we can do about it, but also has a very good section on what you can do to save yourselves, is called The Clash of Generations: Saving Ourselves, Our Kids and Our Economy. The last, the software that I know that I think is excellent, and also free, by the way, is at www.esplanner.com/basic, and Larry, what was the other one? Maximizeyoursocialsecurity.com?
Larry: Yeah. We have, actually…esplanner.com, just without the “basic”, is our more detailed financial planner, but the other program is called maximizemysocialsecurity.com, and that’s just a standalone Social Security program that helps you figure out all this stuff that’s so complicated.
Jim: Okay. The thing that I wanted to add to your idea of holding off and delaying, because the analysis that I did…actually, at the time when you actually added a whole section, you were allowed to give back your Social Security. Now, since then, that law has been repealed.
Larry: Yeah, because I, and others, made a lot of noise about that. The Social Security Administration decided to limit people’s ability to repay and reapply for their benefits with no interest charged whatsoever and start them up at a higher level. That ability has been limited to just one year. Before, you could do it at basically any age between when you started the benefits and age 70. That was the only, you know, the time that it would make sense, but that option is no longer on the table. Instead, you only have a year. So, if you have actually started your benefits within the last year, and you think you’ve made a mistake, you do have the option to repay everything you got. However, if you started taking Medicare, you’re gonna have to repay not just what you got in your, you know, Social Security check, but they subtracted your Medicare premiums from your check, so you’re gonna have to pay those as well when you restart.
Jim: Right, and when you wrote that it was a good idea to give it back, I took it a step further and said if you give it back, you get a tax deduction and then do a Roth IRA conversion in the same year, and what I wanted to add to…which is now, obviously, not good law, except for the one year, but what I wanted to add is one of the advantages of holding off and delaying, which is what you advocated in general, subject to a couple exceptions early on, was that if you are delaying your Social Security, and let’s say you are retired and you have other funds to spend, particularly if you have money outside retirement plans, then you’ll be in a low tax bracket because you don’t have your wages, you don’t have your Social Security, you don’t have your minimum required distribution from your IRA or retirement plan, is that is the ideal year to make a Roth IRA conversion. If you have this period for a number of years, then you can actually do a series of conversions, and I ran some numbers…now, I only ran them until age 86, but the difference between doing…even if you were gonna do small Roth IRA conversions, even if you took your Social Security early, but the difference between waiting and doing the apply-and-suspend technique is…the numbers I ran were you were better off by $219,000, and that’s in today’s dollars. And then, if you live until age 86 and you die and you leave everything you have to your children, that you will have so much more money in the Roth IRAs and that will be very advantageous for them and they’ll be better off by more than $500,000 in today’s dollars. So, it was true when you said something like this isn’t only a good strategy for lower and middle income, but also for upper income, because, frankly, you don’t even have to be really upper income to take advantage of that. There’re just enormous benefits of using the best strategies for Social Security. I want to add to the table the synergy of figuring out the appropriate Roth IRA conversion along with the best Social Security strategies and I actually think it’s a synergistic combination that can be calculated together.
Larry: Yeah, so our software, ESPlanner, the one we sell for $199 to households called ESPlanner Plus is ideal for figuring out whether the Roth conversion is going to increase your living standard. You’re exactly right, Jim, that if you have an IRA or a 401(k) that you can convert to an IRA and then to a regular IRA, and then do the conversion to a Roth IRA, it’s ideal to do it during a period when your tax bracket is low. When you then take your money out, let’s say, starting after age 70 from the Roth, the Roth will not be counted as adjusted gross income for purposes of determining whether or not Social Security benefits are subject to taxation. So, the play here is to take out your 401(k) and IRA money when your tax rate is low. That’s part of the play, but the other play is to have the withdrawals occur from a Roth once you start taking Social Security benefits. Social Security benefits are subject to federal income taxation and there are different thresholds and the thresholds depend on your adjusted gross income. So, if you can keep your adjusted gross income down, not as much of your Social Security benefits will be subject to taxation, and up to 85% of your Social Security benefits can be subject to taxation if we’re talking about somebody with a, you know, even a 20% marginal tax rate. Eighty percent and 20% is, you know, it’s another 16% of your Social Security benefits going away. So, that’s not any fun either. So yeah, you’re absolutely right that there are ways to take Uncle Sam’s best deal, and Uncle Sam is, in effect, telling us that we have the options to decide when we want to pay our taxes and when we want to take our Social Security benefits and which ones we want to take. By playing around with these different choices, we can, in effect, figure out how much we want to actually pay Uncle Sam and get from Uncle Sam. So, it’s like a freebee waiting there if you can actually optimize, and we now have the tools to do this, and they’re affordable. You know, I gave you the example of saving somebody $400,000 just by buying a $40 product, and that’s certainly worth the investment, and if your people aren’t happy with it, we would refund the payment. And I don’t make my living out of this software. I basically keep five American engineers employed, which is a huge honor and privilege and pleasure. But I’m an academic. I work for Boston University. I don’t make any money off of my company. I’m just there to, from my perspective, keep some people employed, but also to help people with this incredibly complicated system and these decisions.
Jim: Well, Larry, you know, I would love to keep talking about Social Security and Roth, but you have so many other areas, and I do want to mention a couple of the ideas that you had in two of your books, Spend ‘Til the End and The Clash of Generations: Saving Ourselves, Our Kids and Our Economy. One question that I did have for you, I know in Spend ‘Til the End , you were a big fan of annuitizing. Annuitizing is, in effect, where you, in lieu of a pension, give an insurance company a certain chunk of money and, in return, they give you a monthly income for the rest of your life. Or, perhaps if you’re married and you want to protect your spouse…
Larry: Hey Jim, I need you to shout a little bit because I’m really losing you.
Jim: Okay. All right.
Larry: That’s much better.
Jim: Okay. I wanted to mention that you were earlier a big fan of annuitizing, where you, in effect, give the insurance company a certain chunk of money, and in return, they give you an income for the rest of your life. Or, if you’re married and you want to secure both your and your spouse’s income, they would give you a smaller amount, but they would give it to you for the rest of both of your lives. I know that you are a fan of the idea of annuitizing, particularly for people who didn’t have traditional pensions, and I was just wondering what your thoughts were on annuitizing now that interest rates are so low, whether you still think annuitizing is a good idea, or whether you think it’s a good idea, but maybe we should hold off a little bit until interest rates go up?
Larry: Well, I guess I would try and wait a little bit to see. I think real interest rates will go up. The most important concern I have about annuitizing is that you’re making a bet and there are two concerns.
One is inflation. So, you really want to buy an annuity that’s indexed for inflation, that’s protected against inflation. I wouldn’t touch any annuity that’s not inflation indexed, and I’m talking about 100% inflation indexed. I’m not talking about an annuity that’s graded, that grows at, let’s say, 3% a year. That’s not protecting anybody against inflation. I mean, the insurance companies will claim that’s an inflation protection, but it’s not because if inflation goes to 10% or 15% or 20%, which it certainly could, given how much money Ben Bernanke has been printing, he’s more than tripled the basic money supply since taking office, or since 2007, we could have very high inflations. So, a 3% growth in your annuity will mean nothing if inflation is 10% a year. It’ll just be wiped out. So, if you’re buying an annuity that’s 100% inflation indexed, you know, the risk is you’ll die, and then your kids will not inherit so much money because you would’ve spent it on this thing that disappears when you die.
But the big advantage is is that if you continue to live, you will get this payment, but then comes the second caveat, which is will the insurance company be there when you are? In other words, if you live to 100 and you’re 70, you make it thirty years, will that insurance company still be solvent and be there to pay you? So, you don’t want to buy all your annuities from one insurance company. You want to think about hedging that insurance company risk. You know, the company that has pretty affordable annuities right now, I’m not sure if they’re still selling the inflation indexed ones, but for a while there, the cheapest ones were from AIG. Now, we know what happened with AIG. You could say today that AIG’s the safest insurance company around because it’s basically owned by the government, but I think the government’s probably divesting its stock, or maybe has already. We all know what happened to AIG, and that could happen to the next insurance company that we buy an annuity from. So, you have to be careful about what company you’re using and not put all your eggs into one company, not buy everything from one company.But, if you do that, and if you get an inflation indexed annuity, and you wait a little bit until real interest rates go up (which they only have one direction to go, which is up), then I think this is a good investment because you want to build a floor to your living standard, a safe floor. Having a house gives you a stream of housing services that are safe. Having an annuity gives you a floor. Having Social Security benefits gives you another floor. So, you’re building floors to your living standard, and then things like investing in the stock market, they can be upsides to your living standard if you don’t count on that money. If you say, “Look, I’m gonna put money in the stock market. I’m gonna treat it like going to the casino, and if it does well, I’ll take the winnings and I’ll convert them to safe assets. So, like a safe annuity, I’ll buy more safe annuities, and then I’ll spend more out of this higher floor. But I won’t count on the stock market doing well because if I do that, if I spend assuming the stock market will do well, I’m setting myself up for a possible decline in my living standard because the stock market might fall apart like it did in 2008, in which case, I’ll have to have a dramatic decline in my spending and my living standard, and that’s not really what anybody wants.” So, I call this kind of strategy ‘upside investing,’ and our software at ESPlanner.com is set up to do upside investing for people, or show people how to do that.
Jim: Well, one of the things that you mention in your book is that we are, in your own words, “broker than broke,” and you have some really not terribly optimistic thoughts about what might happen to the United States. Before I even get to those, let me circle around back to Social Security and let me ask you about the, let’s say, potential argument against delaying Social Security, “Gee, how do I know that the Social Security system will even be there? I’d better take it early. Yeah, that’s great that I’m gonna get an extra $400,000 if I make it until age 90 or 100,” or whatever age you calculated, or the one I did, which was $219,000, but what happens if the Social Security system goes bust? And probably you, as a world-recognized economist, are in a much better position than probably the vast majority of people to answer that objection.
Larry: Well, that’s a very good question. Social Security is in really bad long-term fiscal shape. If you look at Table 4B6, 4B6 of the trustee’s report that was put out in April, you’ll see that the Social Security system is 32% underfinanced. So, this means what we really need to do is raise taxes, FICA taxes for Social Security, which is a 12.4% tax rate. Now, we have to increase that by four percentage points up to 16.4%, starting immediately and permanently, or we have to immediately and permanently cut everybody’s Social Security benefits, including disability benefits, by 23%.
So, this system’s in really crazy shape and President Obama, who I love dearly on a lot of fronts for a lot of reasons, is saying the system just needs to be tweaked. That’s a gross misstatement and it’s a huge disservice to the public and to the next generation who’s going to have to try and pay this huge bill. The reality is is that Social Security is in terrible fiscal shape if you look at the right numbers, and the right numbers are sitting right there in the trustee’s report in Table 4B6. What this means is that they’re going to have to…at some point, there’s going to be a crisis.
Now, for current retirees, I don’t think there’s any possibility of their benefits being directly cut. What may happen is that income tax rates may go up, so the people that are higher earners end up paying higher tax rates on the 50% to 85% of the Social Security benefits that are subject to taxation. And then, we might also see the ceiling on the amount of earnings that are subject to taxation lifted. That’s now about $113,000 that could be completely lifted. That would deal with about 50% of Social Security’s long-term problem if we made everybody who was earning more than $113,000 pay another 12.4% of every dollar they earn for the rest of their lives. But the rich people don’t like to pay taxes, and losing 12.4% of most of their earnings won’t make them happy.
So, we’re in a huge dilemma here. Our software is set up to allow you to specify that there will be benefit cuts, but I think that’s still a very unlikely scenario for people that are very close to retirement or are already collecting benefits. I see the government trying to postpone addressing this thing by doing something that affects younger people adversely, but does it in very convoluted ways that nobody will actually see. I mean, if you look at the actual tax code, it specifies that taxation of Social Security benefits and it’s incredibly complicated. The worksheet for that, you really look at that, that’s an incredibly complicated piece of tax legislation. And right there, the one page that’s in the IRS form, it’s just very convoluted. Nobody can really understand that easily. So, we say that 50% to 85% of your benefits can be subject to taxation, and that helps describe it. The thing is much more complicated than that when you actually look at the details. And that’s what this government’s been about, and prior administrations, they make things so complicated that nobody can actually see how much they’re being screwed.
We’re also printing out money like crazy. Twelve cents of every dollar the government is spending is just being printed out of the printing press by the Federal Reserve to pay the government’s bills. And more of that will happen in the future. So, we could have very high inflation, which will hurt the economy and indirectly tax people because the money they did have will suddenly become worthless, or worth less, and we’ll also have all these hidden extra taxes. So, it’s not a happy prospect for Social Security.
I don’t want to suggest it is, but I still think that, politically, you’ve got 38,000,000 members of the AARP standing ready to beat senators and congressmen over the heads with their canes and wheelchairs and walkers if anybody tries to touch Social Security. So, even the indexation that President Obama was suggesting got a lot of flak, and President Bush, of course, tried to talk about privatizing Social Security for younger people, or partially privatizing, and that led to a huge firestorm. You had representative Rostenkowski before he got into trouble for stealing money from the Senate by issuing stamps, or whatever he did, stealing money from the stamp kitty, they almost drove him out…you know, old people were actually going after him, literally, with their canes in Chicago for suggesting that they should pay a premium for drug benefits. And so, Bush just gave them the drug benefits for free: Medicare Part D. And that whole bill, about $15 trillion, was being left for our kids and future kids.
So, the big moral issue of the day is generational policy. It’s a disgrace. It’s fiscal child abuse. Social Security actually is in terrible shape, but compared to the overall finances of the country, of the government, it actually looks pretty good! But the overall picture is that we need not a 32% tax hike, but a 64% tax hike for all federal taxes to pay all the government’s bills that are projected to come due, and this is according to the CBO’s (Congressional Budget Office’s) projections.
So, we’re talking about a country that’s completely underwater fiscally and printing money like crazy. We are looking like a developing country. We’re looking like Argentina when you actually look at the policies we’re running, and everywhere you look cries out for fixing things fundamentally: Social Security, healthcare, we’ve got Medicare and Medicaid employer-based healthcare that are driving us broke. Now, we’re adding Obamacare, which has a great result, which is gonna insure tens of millions of people. It’s a marvelous thing, but it’s a catastrophe, the way this is set up. It’s gonna be extremely expensive. It could explode in costs. So, you’ve got potentially four healthcare systems, each of which is driving the country broke, and then you’ve got a tax system which is unspeakable, and you’ve got a banking system which is unsafe at any speed.
So, if people are interested, we discuss in this book, The Coming Generational Storm, Scott Burns and I, how to fix this stuff. It’s very simple how to do it, and I have a website called thepurpleplans.org that lays out very simple plans that have been endorsed by many Nobel laureates and by top economists for fixing these problems, fundamentally and very quickly. But we don’t have any leadership in Congress or in the White House to actually make this happen.
Jim: You know something, I hate to interrupt, but we’re close to the top of the hour. I know we have one more break, but I do want to come back and ask about safe withdrawal rates when we get back from the commercial. Could we have a commercial, David?
David: Yeah, we can.
David: And we have about another minute, so go ahead.
Jim: I wanted to thank our guest, Larry Kotlikoff, and he has given us a huge amount of actual, great information. I am going to recommend two of his books. One is called Spend ‘Til the End by Larry Kotlikoff and Scott Burns and the other one is The Clash of Generations: Saving Ourselves, Our Kids and Our Economy. Also his software, which can be accessed at www.ESPlanner.com. Larry, we have about one minute left. Can you tell us a little bit about safe withdrawal rates in one minute? Because I know you have some important thoughts on safe withdrawal rates.
Larry: Well, your goal is not to…this 4% rule, which is spend 4% of your assets every year, is not particularly appropriate for anybody. These rules of thumb are nuts. What you’re really trying to do is withdraw at a pace so that you have the same living standard through time. This ESPlanner.com has the software that actually can figure out how much you can spend. It’s not so much how much you withdraw. The withdrawal issue is really about trying to minimize your tax burden. You want to take out the money at times when your tax rates are low, or again, do the conversion to Roths so that you can limit the taxation on your Social Security benefits. The real issue is smoothing your spending given your withdrawal pattern. So, you want to do two things: optimize the withdrawal pattern, but also then smooth your spending. And the software can help you with that.
Jim: Thanks again, Larry.
David: Okay, and please join us for the next edition of The Lange Money Hour on Wednesday, July 3rd at 7:05 when our guest will be P.J. DiNuzzo, a nationally recognized expert in investment management, and one of the first 100 Dimensional Fund Advisors.
James Lange, CPA/Attorney
Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans. Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.
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