Originally Aired: April 21, 2010
Topic: Surprising Insights for Taking Social Security with guest Larry Kotlikoff, PhD
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Surprising Insights for Taking Social Security
James Lange, CPA/Attorney
|Click to hear MP3 of this show|
- Introduction to Dr. Larry Kotlikoff
- When To Take Social Security
- When You Should Take Your Social Security Early
- When You Should Give Back Your Social Security
- When Should Your Spouse Take Social Security
- When You Should Apply for Medicare
- The Benefits of Immediate Annuities
Nicole: Hello, we’re talking smart money. This is Nicole DeMartino from the Lange Financial Group in Squirrel Hill. Thanks so much for joining us. Today, we’re going to be mixing it up a bit, focusing most of our attention on Social Security. First, of course, let’s start with a few introductions. We’ll start with the president of the Lange Financial Group, Jim Lange. Jim has been practicing for nearly thirty years here in Pittsburgh, and is a CPA and the author of the best-selling book “Retire Secure!” Jim is a nationally-regarded expert on the topic of IRAs and Roth IRA conversions and is the founder of the Roth IRA Institute, which specifically educates financial advisors all over the country, and that certainly has been keeping him busy these first two quarters. Now, joining us tonight, we have the distinct pleasure of hosting our guest, Dr. Larry Kotlikoff, coming to us from Boston University, where he is a noted economics professor. Dr. Kotlikoff earned his doctorate from Harvard University. From there, his vitae is impressive, to say the least, and it goes on and on. As I said, he is currently at Boston University, but he’s taught for many prestigious institutions, such as Yale and MIT, and has been a consultant for many Fortune 100 companies and world banks. If that isn’t enough, Dr. Kotlikoff is responsible for writing hundreds of articles published in the world’s most notable economic journals, and also, he’s written fourteen books. His latest book is entitled “Jimmy Stewart is Dead.” This book is said to be brilliant, telling the truth about our current financial system, a truly stimulating read. You can check it out on his website, www.kotlikoff.net. Welcome, Dr. Kotlikoff, thanks for joining us.
Jim: And I wanted to add a quick word. Back in May, 2008, there was a conference sponsored by New York University in New York City. It had some of the top academic and private sector experts, and the stated purpose of the conference was to determine an algorithm for what money to spend first during retirement. Larry was on that program, I was on the program, and the day before the official start of the conference, they had all of the speakers crowded into this tiny little Chinese restaurant, and I was squished next to Larry and a couple of other people, and I was so impressed by what he was saying, he had so many original, unique thoughts, and one area that I thought was really outstanding, and his advice just went so far against the grain of what most people were doing, was in the area of when to take Social Security. He just has some great information, and the other thing is, he backs up everything he says with extensive, quantitative peer-reviewed analysis, so I was really delighted when he agreed to be a guest on tonight’s show. So, welcome Larry, and thanks for joining us for tonight’s show.
Larry: It’s a pleasure. It’s great to be with both you and Nicole.
Jim: Well, you have some, I would say, controversial, to say the least, opinions on when to take Social Security, and I have, I’m sure that there’s a lot of listeners out there who are interested in taking Social Security as soon as they’re eligible, maybe at 62 or, perhaps 66 at the latest, but that doesn’t seem to be consistent with some of the advice that you have been giving. So, I thought I would just kind of throw an open question to you as to some of the things that our listeners should be thinking about on the issue of when to take Social Security.
Larry: Well, so I’m speaking as an economist, and economics has a pretty clear view of these issues, which can differ quite dramatically from what actuaries have to say, and the Social Security Administration is really run by actuaries. There’s a lot of really fine people there, and the top actuary, Steve Goss, is a close friend of mine, nothing about actuaries, you know, the definition of an economist is somebody who is good with numbers but doesn’t have the personality to be an actuary. So, no offense to the actuaries, but the actuaries are kind of into their actual calculations, which are, let’s think about somebody’s life expectancy. If he’s 60, and he’s gonna die, on average, at age 85, then he should take his Social Security benefits as early as possible, because he might not live that long. Economics takes a different approach. We say, look, you have to plan to live to your maximum age of life, not your expected age of life. You’re not an insurance company. You’re an individual, and you could actually make it to your maximum age of life, which, let’s assume, is 100. So, you can’t count on dying on time. You have to plan to live to your maximum age of life, because you may actually do so. So consequently, in order to provide for living that long, you need to try and buy insurance against longevity, and the best way and the cheapest way to buy insurance is through the government. This longevity insurance, this annuity insurance, is most cheaply provided by the Social Security Administration by just simply delaying when you start collecting your benefits, because the longer you wait, the higher the benefit will be. So, compared to taking your benefit at age 62, the benefit that you’ll get at age 70 by waiting, will be roughly 76% higher in real dollars, and today’s dollars just by waiting. Now, you have to give up eight years, and of course, you might die, but that’s the downside. But, the upside is, you’ll have a 76% higher benefit starting at age 70 that will continue for the rest of your life, and knowing that you’re gonna have this much higher amount of money coming in will allow you to spend more of your regular assets now in the short-run. So, you can actually have a higher living standard, not just starting at 70, but starting really immediately, assuming you have enough resources to really cover that time gap, that you’re not too cash-constrained. So, when you run this analysis in terms of trying to figure out how you can maximize somebody’s living standard, and I have a company on the side called Economic Security Planning, which produces software which calculates people’s living standards. We find that when we run our software, that there’s a tremendous increase in your living standard, again, not just beyond age 70, but right away, assuming you have the resources, whether is retirement account assets or regular assets, to cover that eight-year gap. There’s another good reason for waiting, which is that there’s a free spousal benefit to be had for people that are married, starting when after both spouses have reached retirement age, one of the spouses can collect spousal benefits for free, in a sense that they can delay or defer collecting their own retirement benefits, and they can defer that until age 70, but one of the spouses can collect spousal benefits off the other spouse’s record for free starting at his or her full retirement age. They can’t both do it unless they’re divorced, but if they’re married, one of them can do it, and they can get, you know, $10,000 or $15,000 a year for free, in effect, because it doesn’t reduce how much of their own retirement benefits that they’re going to be getting starting at age 70.
Jim: I do want to go back to that point, but let me tell you one of the reasons why I find this analysis so attractive. So, you’re talking about the difference between, perhaps, an economist and an actuary, now let’s throw in a Roth IRA guy, which I would call myself, who is very interested in developing a tax-free source of income for our listeners, and so I am motivated to figure out what is the best way to get tax-free income, and, interestingly enough, Roth IRA conversions, and the best time to do a Roth IRA conversion is when you’re in a low tax bracket. So, when are you in the lowest tax bracket? You’re in the lowest tax bracket after you retire, before 70 ½ so you don’t have your minimum required distributions, and assuming that you have after-tax dollars, or money outside of IRAs, to live on, you can live on that money. Now, what you’re saying, Larry, is defer your Social Security, which also is keeping your income down, it’s also not causing taxation on the Social Security income when you make a Roth IRA conversion, and so, that fits in perfectly with, let’s say, some of the planning that I’m doing.
Larry: Right, we agree, and software we have can show you exactly how big an impact on your living standard that will imply, and you’re absolutely right that the time to convert is after you’ve retired and you’re in a lower tax bracket, and before you’ve taken your 401(k) money, well, you take some of it out and convert it to IRAs and then convert it from an IRA into a Roth, and the basic idea is to try and spend the 401(k) money, either convert it, or spend it before you start taking your Social Security benefits so as to not trigger a higher taxation of your Social Security benefits under the income tax, and you just said this a moment ago, that when you’re withdrawing money after you’re taking Social Security benefits from a Roth, that’s not counted as part of adjusted gross income for purposes of figuring out the taxes on your Social Security benefits. Whereas, a withdrawal from a 401(k) account, that is counted as part of your adjusted gross income. So, by taking out the Roth money at the time you’re taking your Social Security benefits, rather than the 401(k) money, this is a way of getting, maybe not to zero taxes but to lower taxes. You’re into what I’m into, which is to try and take Uncle Sam’s best deal.
Jim: Well, that’s right, and I just find that there’s a huge difference between having an optimal strategy, and I’m just talking about the Roth IRA conversion and when to convert and how much to convert, and as you certainly are aware, that now that people with incomes higher than $100,000, so you have a whole new field of people who are eligible for Roth IRA conversions, and now we have two tax increases. One is the expiration of the Bush tax cuts, and the other one is the new surtax on investment income, so we’re gonna have some significant tax increases in the Roth IRA conversions, and taking Social Security later were good then, but after these tax increases, they’re really gonna be terrific.
Larry: Yes, but it’s tricky. You got to time this exactly right to really get the maximum benefit, because you want to make sure your bracket’s not too high. If you take out too much in a given year to convert, you’re suddenly going to be pushed into a higher tax bracket. Now, from what I understand, and Jim, correct me if I’m wrong, this ability to convert without limit continues into the future, so it’s not just a 2010 opportunity, it’s an ongoing opportunity. So, one wants to look carefully at when exactly is the best time to convert, and certainly, before one starts taking in Social Security benefits, I think is the time, so that, again, the more money you’re using to spend in retirement is coming from the Roth as opposed to the 401(k) that’s gonna trigger higher Social Security benefit taxation.
Nicole: Dr. Kotlikoff, I need to step in for one second. Jim can give you your rebuttal. We need to take a short break. We’ll be right back talking more smart money with Jim Lange and Dr. Larry Kotlikoff.
Nicole: This is the Lange Money Hour, where smart money talks. I’m Nicole DeMartino here with James Lange, CPA/Attorney and best-selling author of “Retire Secure!,” and also, our distinguished guest Dr. Larry Kotlikoff, economist at Boston University and the author of his most recent book, “Jimmy Stewart is Dead.” Welcome back.
Larry: Thanks so much.
Jim: Larry, you said that, in general, you like the idea of people waiting until age 70 to take Social Security, and you put it in the framework of you could live a long time, and you want to maximize what you’re going to get over your lifetime, and don’t think of it like an actuary, where you’re actually comparing present values. Let’s say, for discussion’s sake, that maybe you are not in the best of health, and it is highly unlikely that you will live until age 100 or even to your life expectancy, do you have some guidelines for people who are not likely to live to full life expectancy, or well beyond that? I guess what I’m looking for are times when it doesn’t make sense to wait until age 70.
Larry: Unless you know for sure, your maximum age of life is really your maximum age of life, so unless you’re absolutely sure that you will not make it to 100, you should plan to live until 100, because you might. But what economics also says is that those who have higher probabilities of dying early should take a gamble. If they’re not really, really risk averse, they should take a gamble and spend more of the resources at younger ages and plan on a lower living standard if they make it to, say, age 85. They could gradually reduce their living standard, maybe, by 2% a year between 85 and 100. So, unless you have a terminal disease, you know, my mom’s 90 and she’s getting younger every day. There’s lots of people out there who are gonna make it to 100. When the baby boomers are fully retired, we’re gonna have enough centenarians to fill up Washington D.C. The demographics are really quite interesting and shocking. We’re gonna have enough people over 85 to fill up New York, Los Angeles and Chicago. So, you can imagine what it would be like driving in those cities with those people.
Jim: My mother’s old enough that she won’t let me mention her age publicly. But, let me ask you this. One of the objections that I can picture a lot of people having, because I’ve certainly had this discussion, and in general, I have been a fan of holding off on Social Security, perhaps for different reasons than you, but I’ve independently come to the same conclusion. I get the answer, “Well, gee, you know, right now, Social Security is paying money. If I don’t take it, how do I know that they’re not gonna change their minds, stop paying it, and then I will have missed taking it all those years.” What would your answer to that common objection be?
Larry: I think the government would default on its national debt before it defaulted on Social Security benefits to people over 62, and I think anybody, if the government were to give somebody who is beyond age 62 less than they had been promised, that would be, in effect, equivalent to cutting somebody’s current benefit, which is, you’d have to have the government in extreme distress, now that could happen, because this government is running a fiscal policy which looks to me to be a lot worse than Greece’s fiscal policy. So, we could get into that situation, but I think that would be the last thing to be cut, are the Social Security benefits to the people who are already receiving them or, in effect, are postponing their receipt.
Jim: Alright. Now, the other thing that you mentioned in some of your literature and, I thought that I know that you have, is a special area that is almost counterintuitive, and I would imagine people might hate hearing it, but I actually think that it makes a lot of sense. So, let’s say for discussion’s sake, that you are already taking Social Security. Maybe you’re in your mid to late sixties, you’ve been taking Social Security for a while, let’s say you don’t even really need the money, but you’ve just been taking it just because you think, “Well, it makes sense to take it.” You’re actually, sometimes, proposing that we give it back. Can you tell us a little bit about that, because it’s bad enough that you’re telling us don’t take Social Security, now you’re telling us the money you’ve taken, give it back.
Larry: Well, give it back and re-apply for even higher benefits, and that’s, in effect, what you give back is a way of buying a higher annuity. The amount you pay back, what you have to do is, using the Form 521, which is on the Social Security website, and we discuss this at www.esplanner.com, under “Case Studies,” we have a case study called “When should I take Social Security?” The idea here is you have an option, now Social Security may change this option in a couple of years, so if people are interested in doing it, they should do it right away. But right now, you have the option of taking all the benefits that you received in nominal dollars, and just paying them back, and they payback is tax-deductible, or you can alternatively take a tax credit for the past taxes that you paid on your Social Security benefits. So, there’s a tax break. In addition, you don’t have to pay any interest on the money that you received in the past when you pay it back. And so, you just pay back the dollars that you actually received, if you received $50,000, you pay back $50,000, and it’s tax-deductible. Then, let’s say you’re 70, you could reapply immediately for a higher benefit. If you’re 68, you could wait until you’re 70 and, at that point, reapply for the age 70 benefit. So, it’s like resetting the clock. You’re starting from scratch. You have that option, and we found, using our software, that this can be a significant enhancement to people’s living standard, because annuities are, in general, a great way to raise your living standards, especially if we’re talking about getting that annuity from Social Security, because Social Security is going to be the last thing to go in this country, in terms of going broke. AIG may go broke, other life insurance companies may go broke, well, AIG, who knows, AIG is basically owned by the government at this point, but insurance companies, in general, can go broke, but it’s not likely that Social Security is gonna renege on paying these benefits.
Jim: So actually, in a way, if you’ve done that, you would have had an interest-free loan from the government. You give the money back, and economically, you’ll be far better off, particularly if you live a long time, by giving the money back and getting a higher benefit for the rest of your life.
Larry: This is like found money, because we’ve done calculations, again with the software, where you take a 70-year old who started collecting benefits at 62, by doing this repaying and paying back and reapplying for higher benefits, they can have a 10% or 15% higher living standard for the rest of their life. Every year for the next 30 years right up to age 100, their living standard could be materially higher. Now, it depends on the circumstances. If you have $10,000,000, then, percentage-wise, this is not gonna be a 10% increase of living standards, but if they’re middle class or lower income, this can be a major deal, and it’s perfectly safe. So, I like to focus on things, as I think you do, Jim and Nicole, on ways to raise somebody’s living standard that entail no risk. They don’t involve putting your money in the stock market and taking a gamble on how well that does. We’re talking about things that are absolutely risk-less, or as risk-less as they can get in this society.
Jim: And the reason is, is because right now, the government has that program. Now, at any point, they could cut that, but what you’re saying is, if you go ahead and do that, then you will be guaranteed the higher benefit now.
Larry: Yeah, I know people who have been thinking about this for a year-and-a-half now, and a number of people have called me to tell me about that they’ve done this, and to thank me for writing about it. Other people, Janet Novack at www.forbes.com has written about this, and people at Prudential insurance company have written about this option, but we were able to quantify it, we were actually able to find out that it’s a major economic advantage, because, when you get a 76% higher benefit immediately starting at age 70, I you are age 70 when you do this conversion, sure you have to hand back a bundle of money, but you’re just paying back the nominal dollars and there’s no adjustment for inflation, there’s no interest charge, there’s no adjustment for the actuarial factor involved in the fact that you’re getting an annuity to begin with. You just pay back those dollars, and bingo, you’re starting with a 76% higher benefit for, you know, whether it’s 70 or 76%, it’s gonna be one big number depending on your age and your circumstance, and that’s gonna take you right through age 100, for sure, so it’s a great way to improve your living standard and be able to sleep at night.
Jim: Well, I agree with that, and I have actually seen those ideas and have run some other numbers, not using your software, although frankly, I can’t wait to use your software. By the way, speaking of your software, could you tell us a little bit, because I know that you have a professional model that’s gonna cost people some money, but I also understand that you just won an award recently that has this software that our listeners might be interested in, and, as I understand it, it’s free.
Larry: Yeah, we have a version up that we provide as a public service. It’s called ESPlannerBasic. It’s at www.esplanner.com/basic. It’s a free, simplified version of our download program which we sell to the public, with Monte Carlo simulations, for $199. Without it, it’s $149. And we also market it to financial planners for $750 a year, and so this free version, this ESPlannerBasic, costs nothing. You can go there right now, www.esplanner.com/basic, and play with that program. It can do a lot of what the download versions can do, so if you can’t afford the download versions, by all means, just use the Basic version, and that was just named by Money magazine in this month’s edition the number one money web program, and also www.cnnmoney.com, we’re ranked number one. And there’s a good reason, because we’re the only software program that does a very, very careful job on taxes, on Social Security benefits, on state income taxes, and it also goes about this in a way that really makes economic sense. We’re trying to figure out for people how much they can spend each year, and how much they should save each year, in order to have a stable living standard for each person. So, basic planning is focused on hitting some target. They say, well, you should target to spend 85% or 75% of your pre-retirement earnings, and that target may be far too high or far too low depending on the particular household, but it’s a rule of thumb that the industry has come up with.
Jim: Which I disagree with completely, by the way.
Larry: Yeah, I refer to it as a rule of dumb, because the target for each household really needs to be tailor-made, it’s individual and specific. Our software is internally finding out the target and how much you should spend every year. It doesn’t ask you, you know, my target, personally, Jim and Nicole, if you asked me how much I would like to spend at retirement, I’d like to spend a billion dollars a minute. That’s what I’d like to spend.
Jim: I’m glad you don’t have high aspirations.
Larry: Yeah, and if I think about it, it could be ten billion a minute. So, you immediately see that this is kind of a ridiculous question. What we’re really trying to do is set a spending target for post-retirement that gives us a similar living standard to what we’re experiencing before retirement, because we’re not interested in splurging today and starving tomorrow. We’re not interested in the opposite. We don’t want to starve today and party at 85. We want to have a smooth ride. That’s what economics’ diminishing returns is telling us. We don’t want to eat all our cookies at one sitting. So, that’s a very, very complicated question to answer. You have to use advanced mathematics, and the right technique to be answered in two seconds, which is what our software can do. So, we got a patent for the technology, it’s called Dynamic Programming Technology, and we were able to solve this particular problem in two seconds with the way that we came up with the methodology.
Nicole: You know what, Larry, we’re gonna take a quick break. We will come back. We’re gonna talk a little bit more about your software when we come back. You’re listening to the Lange Money Hour with Jim Lange and Dr. Larry Kotlikoff, and we’ll be right back.
Nicole: We’re back at the Lange Money Hour, where smart money talks, and we’re discussing Dr. Kotlikoff’s award-winning software which you can download for free. The website’s www.esplanner.com/basic. We’re here with Jim Lange, Pittsburgh-based CPA, and Dr. Larry Kotlikoff of Boston University. Okay Jim, back to you.
Jim: Larry, one of the things you had mentioned earlier regarding taking Social Security is, we talked about waiting until age 70. For people who haven’t waited, the possibility of actually giving the money back, which I know our listeners love to hear that, give the money back, so if they listen to you and me, Larry, they’re going to give money back for Social Security, and then they’re going to pay taxes upfront on a Roth IRA conversion. But actually, I think both of those strategies are sound, but could you tell us a little bit about the spousal benefits, and if you’re not a single taxpayer, but rather, you’re a married taxpayer with a husband and wife, and you both have some Social Security earnings, how would that play in? Do you both wait until 70, or should one person take it early? I know other writers have had some opinions on this, and I was probably most interested in yours, because I suspect that you’ve done as well or better than anybody in terms of quantifying these benefits.
Larry: Yeah, well, this is another argument for waiting to collect your own retirement benefit until 70, but then, if you are married, when both of you have reached full retirement age, one of you should go into the Social Security Administration and apply for retirement benefits and suspend their collection until age 70. That’s called apply and suspend.
Jim: What’s the advantage of that over just doing nothing?
Larry: Well, because then, the other spouse, let’s say the husband does this, the husband goes in and, let’s say, his full retirement age is 66. He goes in at 66, and he applies for retirement benefits, but then he suspends their collection, and he tells the Social Security guys, “I’m gonna come back at 70 and start collecting them.” When he does that, then, the delayed retirement credit continues to operate, so he’ll be getting a much higher benefit at age 70 because he suspended their collection.
Jim: This sounds like a loophole to me.
Larry: Well, it’s in the laws. It was introduced in 2002 legislation, so it’s an intentional piece of legislation put in not too long ago. The other spouse, the wife, can then go and apply for spousal benefits, and this will not trigger automatically her own retirement benefits. So, she can also defer her retirement benefit until age 70, and every year you wait, your benefits go up around 8% per year. It’s not compounded. It’s like, you know, if it’s four years, eight times four is 32% higher benefits, but that’s a lot. So, she can get spousal benefits for, let’s say, four years, and then they both start getting their full retirement benefits augmented, the maximum retirement benefits they can possibly get starting at age 70, and she, in effect, gets the spousal benefits for free.
Jim: And when you say spousal benefits, are you saying that the person with, let’s say, a lower benefit should actually start collecting earlier, and the person that would have the higher benefit wait?
Larry: Well, if they’re the same age, then the spouse that has the lower earnings record, only one of the two spouses can get the free spousal benefit, and the spousal benefit is equal to half of the other spouse’s what’s called primary insurance amount, which is basically the benefit they would receive at full retirement, whether they take their benefit full retirement. So, if the lower earning spouse, in general, should be the one who applies for spousal benefits, because the spousal benefit will be higher, but if the lower earning spouse is older than the higher earning spouse, then it might behoove the higher earning spouse to actually come and take spousal benefits. Let’s say that the wife is lower earning and she’s three years older than the husband. So, when he hits age 66, she’s not 69. So, he should then, probably, apply to get spousal benefits off of her record. She should apply and suspend and collect at age 70. But she’ll apply and suspend at age 69. And then, he’ll be getting free spousal benefits off of her record for four years. So, it depends on their ages, and the next release of our software update that we’re putting out in a month or so, is gonna allow maximum flexibility to figure out who should go first, who should do the applying and suspending now. Let me quickly point out that this waiting until full retirement age is critical, because if you try and collect spousal benefits at age 63, and your spouse is already collecting retirement benefits for whatever reason, you’ll be forced to take the spousal benefits right away, and you’ll get an early retirement reduction factor kicking in, so the whole idea here, the whole game, is to not get zapped by this early retirement deduction factor, which apply for your own retirement benefit and also your spousal benefit, and the key thing is that, if you apply for either of these two benefits before your full retirement age, if you apply for your retirement benefit, you’re deemed to also be applying for your spousal benefit, and if you apply for your spousal benefit, you’re deemed to be applying for your retirement benefit. And even if you can’t collect your spousal benefit because your spouse is not yet actually retired, is not collecting his or her retirement benefits, hasn’t either started collecting it or hasn’t filed and suspended, when you finally do start collecting your spousal benefits, if you’ve taken your retirement benefits before full retirement age, when you start collecting your spousal benefit, you’ll have it permanently reduced. So you got to be very careful in this stuff. And this case study, when should I take Social Security, helps you understand these provisions, which are very complicated, but the basic idea, the basic rule of thumb, which I think is not a rule of dumb in this context, is if you can wait, if you’re not cash constrained, if you have other resources to live off of, then you should wait until full retirement, have one of you go in and apply and suspend, have the other go in and collect free spousal benefits, and then both of you get your retirement benefits starting at 70, and that’s the way to maximize your deal with Social Security.
Jim: Yeah, you know, this is such terrific information. I know some of it may be a bit hard for people to catch, but the key, I think, is doing it right and have a, what I call, a running the numbers-type analysis, and then what I would add to that is, if you do that in conjunction with a well thought out Roth IRA conversion strategy, where you have run the numbers, that you’re really talking about a significant difference in the quality of your life or the rest of your life and as a bonus, leaving more money behind for children or other heirs.
Larry: Yeah, absolutely, you can take Uncle Sam’s best deal and that can make a huge difference to your well-being.
Jim: Now, another area that you kind of go the other way on this is when you apply for Medicare benefits. So, I thought, you know, here you’re gonna give some different information, and I thought that perhaps, this was gonna be a little bit easier and more friendly for people. So, maybe, perhaps, you can give us your opinions on when to apply for Medicare?
Larry: Well, as I understand it, when you hit age 65, if you don’t start taking your Medicare benefits immediately, the premiums, which can be quite substantial, when you finally do start applying, you may have to pay a much higher premium for your Medicare benefits. That’s if you are not employed by an employer with a hundred or more employees, so if you’re working for a small firm, the last time I checked, you’re gonna be subject to this kind of Medicare tax, which is, when I take my Medicare benefits, if I delay beyond 65, I’m gonna be subject to a higher premium for the rest of my life, and that can be pretty nasty. So, my advice is that if anybody’s working for a small employer, when they hit age 65 they should go in and take Medicare.
Jim: And that’s parts B and D?
Larry: I think this is basically part D, and D you might be able to hold off on, and A, I think you may be able to hold off on A, as well. I forget exactly the rules on A versus D, but the premiums are really related to part D. So, you may be working for a small employer who’s providing you a health insurance plan at the job, but it may still behoove you to go in and apply for Medicare so that three years later, you’d otherwise have to pay much higher premiums if you waited for three years, let’s say, and you start taking your Medicare benefits at that point. You want to make sure that these Medicare premiums are going to be astronomically high. They’re gonna be astronomically high anyway, because of the fact that Medicare benefit levels are growing and the premiums are related to that growth, so the fact that the Medicare premium is its own tax schedule, you know, there’s this complicated tax system, in effect, a premium calculation that’s based on your adjusted gross income, as well, that goes back and looks back at your AGI for the prior two years. So, we have all of this programmed into our software, and you can see when you run our program, that gee, the Medicare premiums out into the future, they might start around $5,000 or $6,000 a year, and end up around $15,000 or $20,000 when people are 90, because of the projected growth in the benefit level.
Nicole: Larry, I have to interrupt you right now, we need to take one more short break. This is the last one, I promise. We’ll be back in one minute with Jim and Larry, ands this is the Lange Money Hour, where smart money talks.
Nicole: Okay, we’re back with the Lange Money Hour, where smart money talks. We’re here with James Lange, CPA/Attorney, and our guest, Dr. Larry Kotlikoff.
Jim: Larry, one of the major themes that you profess is the idea of a higher standard of living through making smart economic decisions, and one of the things I know that you write about is immediate annuities, which is more or less similar to the old traditional pension plans, that we’re seeing less and less or these days. Could you tell us a little bit about immediate annuities and the benefits that it might have in terms of increasing the living standard for our listeners?
Larry: Well, annuity is really an insurance policy. It’s an insurance against living longer than you expect to live. Again, we can’t count on dying on time, so we might make it to 90, 95, 100, I think something like 40% of married couples who are 65 will have at least one member who will make it to 90. So, there’s really a pretty high probability now of somebody in a couple getting into very old ages. So, an immediate annuity is going to give you a higher return than investing in a bond, because if you die, that’s it. The money that you put down to buy the annuity is gone. It goes to the other annuitants that haven’t died. They’re going to be getting, in effect, a higher income stream because your money is going to help pay their annuity. So, a lot of people are hesitant to buy immediate annuities because they think, “Gee, if I die, I’m gonna lose the money.” But, the real risk here is living. It’s not really dying. If you’re dead, you’re dead, and there’s not gonna be a lot of regret in heaven because you’re gonna have the angels to take care of you and other things like that, and life will be beautiful. You’ll be in heaven, and you’re not gonna need money in heaven. But when you’re here on earth, you’re gonna need money all the way to the very end, and that’s where an annuity can come in to help, and what I believe, though, is that you want to try and get the best deal and one that’s protected against inflation, and the best deal we’ve been discussing is from Social Security itself if you can, in effect, buy a higher annuity by waiting to collect a higher benefit. That’s, in effect, a way to purchase a higher annuity just from Social Security. If you’re already collecting Social Security benefits, and you took them early, you can repay your old benefits and get a higher level of benefit, and that’s another way of buying an annuity from Social Security, but if you’ve already kind of maxed out on those options, then buying an immediate annuity from an insurance company through a financial planner, with an insurance that they might recommend a particular annuity product, is a way of securing this ongoing income stream no matter how long you live. But, I’m very concerned, looking outward, about inflation, about the government printing lots and lots of money to pay its bills, because Uncle Sam is fundamentally broke, so I would be very eager to see anybody who buys an annuity that’s fully inflation-protected. If inflation goes up by 10% and if the price level goes up by 10%, the annuity would go up by 10%. So, we’re not talking here about an annuity that’s graded, that just goes up 3% a year no matter what happens, but rather one whose level is very much tied to the level of inflation.
Jim: Yeah, it’s interesting. I’ve run analysis on immediate annuities, and I did it a little bit more like the actuary, the guy who works at Social Security, and for example, I came up with, and given a whole bunch of assumptions that I don’t want to go through here, that 86 was “the break-even age.” In other words, rather than investing it, for example, at 6%, that you would actually do better if you lived until age 86 or beyond, but if we’re going to look at it like an economist, and we’re going to try to protect ourselves and, in effect buy longevity insurance, then the immediate annuities are even more attractive.
Larry: Right. Economists would say you have to do an apples to apples comparison. If you have $100,000 and one option is to buy an immediate annuity, and the other is to take $100,000 and invest it in the stock market, well, that’s an apples to oranges comparison, because investing in the stock market is risky. If you have an annuity that’s adjusted for inflation, then you have to compare that with what you can get by investing in safe assets that are adjusted for inflation, and those would be treasury inflation protected securities that are called T.I.P.S. They’re yielding about 2% after inflation these days, and annuities could easily yield 4% or 5%, depending on your age.
Jim: And sometimes even more than that. And sometimes, there’s some interesting decisions. If you’re married, you do a one-life, or more typically, two-life annuity, and by the way, we run into a similar conceptual issue, for example, when somebody is retiring, for example, a retiring teacher might choose a one-life or a two-life pension, it’s a little bit similar, and usually, the idea is to protect both the husband and wife. So, more often than not, for married couples with a relatively low-risk tolerance, I’m usually going to recommend a two-life annuity, even if the income stream is a little bit lower.
Larry: Yeah, I agree with that. You need to have the survivors fully protected. Now, a lot of people don’t buy annuities because they say, “Well, gee, I want to give the money to my kids. If I die, the money I just spent on the annuity is out the door, and my kids won’t get it.” Well, I think the way we economists would think about it would be this: if you want to give money to your kids, give it to them right now. You know, just give it to them. Do for them what you want to do, and then, buy this insurance protection about against your living to a very old age, because if you don’t have that protection, what you’re doing is not just putting yourself at risk, but you’re also putting your kids at risk, because if you live to 90 or 95 and you need a lot of extra income because of health expenses, or even just because you’ve run out of your own cash, your kids are gonna have to be the ones that have to bail you out. So, it’s not actually helping your kids to engage in this gamble with them, because it’s much better to make things safe. Give the money you want to give to your kids right now, take the rest of the money and build yourself an income floor, a living standard floor, and annuities are a very good way to do that.
Jim: Well, the thing that I like, you know, what you’re talking about is a combination of maximizing Social Security, and, in the absence of a traditional pension, some type of income from an immediate annuity, and I like the concept of a floor, where you are creating, in effect, a situation where there will always be sufficient money for a roof over your head, gas in the car, food on the table, and perhaps some other investments and other strategies for things over and above that. But I really like the idea of a certain guaranteed income level, and some of your ideas about Social Security, in giving money back, in waiting, and protecting yourself with, in effect, old age insurance with immediate annuities I think is really profound.
Larry: Well, it’s just straightforward economics. If you can bear to deal with these, to think about economics and deal with the government’s complexity, and I’ve had to do that through the course of my career, then you see some ways to really move ahead.
Jim: Let’s see, one of the things that I really love about your analysis, and in certain ways, it’s similar to mine, is that it’s not just some random ideas you came up with, and you said okay, you should do this, is that you actually back it up with very, very detailed analysis, in your case, the program, in our case we call it running the numbers, that combines a number of different areas, so that you actually can come up with a quantitatively superior course of action, whether it be a Roth IRA conversion or a series of Roth IRA conversions, holding off on taking Social Security, applying for Social Security, spousal benefits but still holding off or even giving money back. I think that the idea of quantifying some of these strategies is just terrific.
Larry: Well, thanks so much.
Nicole: Well, thank you, and I think we are wrapping up. These hours go by so quickly. Thank you so much for joining us.
Larry: My pleasure, anytime.
Nicole: You know what, we didn’t talk much about your latest book, but again, I want to tell people where to get it. “Jimmy Stewart is Dead,” you can get that on www.kotlikoff.net, and the software also.
Larry: Well, www.esplanner.com would be for the software, and www.kotlikoff.net will show you the endorsements by five Nobel Laureates, and George Schultz and Bill Bradley, lots of very impressive people, a forward by Jeff Sax, and then at www.amazon.com or Borders or Barnes & Nobles or your local bookstore, go to your local bookstore because they could use the business. I like to support them.
Nicole: Absolutely, well, thank you again. Thanks for joining us today. That’s all. We’ll be back in two weeks. This is Nicole and Jim, saying thank you for listening to the Lange Money Hour, where smart money talks.
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA 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, 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.