HOW SOCIAL SECURITY IMPACTS YOUR DAY ONE

Transcription

1 HOW SOCIAL SECURITY IMPACTS YOUR DAY ONE May 12, 2015 Dave Nocera Stephanie Anthony Paul Adamczyk Prudential Retirement For Institutional Plan Sponsor use Only. Not to be distributed to plan participants or the general public 1

2 Agenda Only three things are certain in life Retirement model then Retirement model now Challenge ahead Making the most of Social Security Benefits In summation 2

3 Only three things are certain in life Only things certain in life are birth, death and change As retirement models continue to evolve the Social Security benefit element is a bedrock we need to better understand Today we will explore four costly mistakes retirees make about Social Security Understanding the value of Social Security Collecting early then regretting reduced benefits for the rest of your life Understanding the various ways married couples can integrate their benefits Understanding the tax implications of Social Security benefits Goal is to better understand how best to employ the Social Security benefit in an individual s retirement planning Future changes to Social Security seem certain stay tuned 3

4 Retirement model - then 4

5 Retirement model - then Three Components of Retirement Income Defined benefit plans replaced 25% to 50% of income for full career participants (1) Individual savings on post-tax basis Social Security replaced 30% to 45% of pay for average paid full career participants (2) Combination of pension, Social Security and personal savings was expected to provide a rough rule of thumb 70% to 80% of final pay necessary to maintain current lifestyle in retirement Assuming housing cost was paid off, this was generally accepted as adequate to provide post-retirement needs Majority of this was in annuity-like payments which protected participants against outliving their money (1) Bureau of Labor and Statistics 1997 Employee benefits in medium and large private establishments (2) How much pre-retirement income does Social Security replace? Alicia Munnell and Mauricio Soto, November 2005, Number 36 Center for Retirement Research at Boston College 5

6 Retirement model - then (3) (3) Prudential Retirement Social Security Calculator

7 Retirement model - now 7

8 Retirement model - now Defined benefit plans are in decline only 21% of US workers have this as their primary plan (4) Now, most US workers have a defined contribution plan as their primary plan (4) Most common match $1 per $1 employee salary deferral up to 6% of pay (replacing previous most common match that provided a 50% match up to 6% of pay) (5) Assuming the participant contributes the amount to obtain the full $1 per $1 match up to 6% of pay for a forty year career and invests the money prudently, this arrangement is anticipated to yield a replacement income of approximately 61% of final pay (6) (4) 2012 EBRI Survey of Income and Program Participation (5) 2013 Trends and Experience in Defined Contribution Plans Aon Hewitt (6) Assumes: Use of RP2014 Mortality table and MP 2014 Projection, for participant age 25 in 2015 retiring in forty years and a 4% interest rate age 65 annuity factor Annual pay increases of 3% Annual earnings of 6% 8

9 Retirement model - now Social Security, which had firmed up its solvency with the 1983 revisions, is in need of an update Replacement ratios reduced to approximately 20% to 35% of pay for most future participants 2010 study shows fund becoming insolvent under certain assumptions in 2037 (7) Ratio of workers to fund beneficiaries slipping from 3 to 1 to 2 to 1 (7) Beneficiaries are living longer (7) (7) The Future Financial Status of the Social Security Program Stephen Goss, Social Security Bulletin, Vol. 70, No. 3,

10 Retirement model - now (3) (3) Prudential Retirement Social Security Calculator

11 Retirement model - now Likely solutions? (8) Increase in Social Security Normal Retirement Age Eliminate wage cap on OASDI tax Change bend points to reduce overall benefits particularly at higher final average pay levels Reduce COLAs Means testing Lower Social Security benefits for future generations Combination of the above (8) Summary of Provisions that would change the Social Security Program - Office of the Chief Actuary Social Security Administration, October 10,

12 Retirement model - now Combination of Social Security, Pension and personal savings can still provide 70% to 80% for full career participant However, leakage caused by participants misuse of defined contribution assets turned over to their control prior to retirement lowers the result Since half or more of the retirement benefit is now coming from non-annuity sources, longevity risk is heightened for retirees Recent paradigm shift in how retirement benefits are provided calls for a review of opportunities available to minimize longevity risk 12

13 Challenge ahead Re-imagine private retirement plans and find approaches to incent changes in saving behavior Consider building longevity insurance aspects into retirement plans to protect participants from outliving their assets There are currently underutilized aspects of Social Security that can build longevity insurance aspects into our current retirement planning remaining portion of this presentation will focus on these aspects 13

14 Making the most of Social Security benefits Timing is everything. 14

15 Making the most of Social Security benefits Earnings Test Benefits commencing before Full Retirement Age subject to earnings test For every year up to the year you reach Full Retirement Age, $1 in benefits will be withheld for every $2 in wages earned above the limit for that year ( $15,720 in 2015) During the year you reach Full Retirement Age benefits are reduced by $1 for every $3 earned above a higher limit ( $41,880 in 2015) No earnings limit exists beyond a participant s Full Retirement Age FULL RETIREMENT AGE Year of Birth Full Retirement Age and 2 months and 4 months and 6 months and 8 months and 10 months 1960 and later 67 15

16 Making the most of Social Security benefits Rushing to collect, then regretting reduced benefits for the rest of your life Compared to earlier generations of retirees, Social Security will replace less of pre-retirement earnings Full unreduced retirement age has risen from 65 to 66 and is heading to 67 for those born after 1954 Collecting before full retirement age results in reduction penalties of between 25% to 30% Focus is sometimes on break-even age, that age at which you could receive more income from starting Social Security benefits earlier versus starting them later. This ignores some key considerations: Potential interaction between spousal benefits and ability to integrate benefits to provide optimal income and protection Ability of Social Security to provide longevity risk protection in the form of retirement income for life; particularly important as less of our benefits are guaranteed for life Collecting before full retirement age forgoes potential 8% per year post full retirement age increases in benefit available until age 70 16

17 Making the most of Social Security benefits (9) (9) Assumes: -Use of RP2014 Mortality table and MP 2014 Projection with a 4% interest rate; Annuity at age 62 deferred to age of collection; Age 30 participant collecting at ages 62, 67, & 70; Age 60 participant collecting at ages 62, 66, & 70 -Annual pay increases of 3%, termination at age 62 -NEA & Wage Base increase 2.5% -COLAs of 3% 17

18 Making the most of Social Security benefits Present Value of Benefits at Age 62 (9) Current Age 30 Current Age 60 $ 40,000 $ 100,000 $ 40,000 $ 100,000 Age ,000 1,120, , ,000 Full Retirement Age 775,000 1,286, , ,000 Age ,000 1,373, , ,000 (9) Assumes: -Use of RP2014 Mortality table and MP 2014 Projection with a 4% interest rate; Annuity at age 62 deferred to age of collection; Age 30 participant collecting at ages 62, 67, & 70; Age 60 participant collecting at ages 62, 66, & 70 -Annual pay increases of 3%, termination at age 62 -NEA & Wage Base increase 2.5% -COLAs of 3% 18

19 Making the most of Social Security benefits Considerations for integration of Spousal Benefits Spousal benefit is based off of PIA at Full Retirement Age Reduced at a higher rate for retirement before Full Retirement Age and does not receive Delayed Retirement Credits Eligibility If Spouse B s benefit is less than ½ of Spouse A s benefit (based on PIA at Full Retirement Age) Amount will make up the difference bringing Spouse s B s total benefit up to the ½ amount Example (10) Spouse A PIA of $2,000; Spouse B PIA of $600 (Assume both are the same age) Spouse B is eligible for $400 Spousal Benefit; total of $1,000 Spouse A starts collecting early, the $2,000 is reduced Spouse B can delay until Full Retirement Age and collect the full benefit at that time Spouse A does not collect early Spouse B can only collect worker benefit of $600, reduced accordingly Full Spousal benefit of $400 will be given once spouse starts collecting (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 19

20 Making the most of Social Security benefits Claiming Strategies for Spousal Benefits (10) File & Suspend Spouse A can file and suspend benefits at Full Retirement Age allowing Spouse B to start collecting spousal benefits Spouse A s benefits will continue to grow with Delayed Retirement Credits File a Restricted Application Spouse A files for benefits Spouse B files a restricted application for Spousal only benefits and delay s worker benefit Can only be done if Spouse B is at Full Retirement Age At this point Spousal Benefit will be based on ½ of Spouses PIA; for our example $1,000. This will reduce once Spouse B starts collecting her own benefit. Combining the Two Spouse A File & Suspend Spouse B File a restricted application for Spousal Only benefit Both worker benefits will grow with Delayed Retirement Credits and Spouse B will be collecting $1,000 spousal benefit (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 20

21 Making the most of Social Security benefits Tax implications of Social Security benefits It s not what you receive in income from Social Security and other pension and savings, it s what you keep Maximum tax on Social Security benefits is 85% on each dollar of benefit received Maximum tax on other pension and savings is typically 100% on each dollar of benefit received Hence, maximizing Social Security benefits helps you keep more of total retirement income 21

22 Making the most of Social Security benefits Combined income formula determines how much of a retiree s Social Security benefit is subject to taxation Up to certain combined income thresholds Social Security benefits are tax free Once first threshold is reached, up to 50% of Social Security benefits are taxed Once second threshold is reached, up to 85% of Social Security benefits are taxed Single persons two thresholds are $25k and $34k Married persons filing jointly two thresholds are $32k and $44k 22

23 Making the most of Social Security benefits It is widely held that tax on Social Security benefits can not be avoided, so most retirees assume 85% of all Social Security benefits will be taxed once retirement income thresholds of $34k and $44k are reached by single and married couples respectively (10) (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 23

24 Making the most of Social Security benefits Combined income formula calculates the portion of Social Security benefits that are taxed as the smallest of: 85% of Social Security benefits 50% of Social Security benefits + 85% of any excess over the second threshold 50% of the excess over the first threshold, plus 35% of the excess over the second threshold The excess refers to the income amount over the appropriate threshold of non-social Security income plus 50% of Social Security income 24

25 Making the most of Social Security benefits Married couple A retires today at age 62 Need $100k in annual income to meet their needs Immediate commencement of Social Security provides $36k annually $64K is taken from savings and other pension benefits to make up the difference Combined income formula calculates amount of Social Security benefit taxed as the smallest of : (1) 0.85 * $36,000 = $30,600 (2) 0.50 * $36, * [($64, * $36,000) - $44,000] = $50,300 (3) 0.50 * [($64, * $36,000) - $32,000] * [($64, * $36,000) - $44,000] = $38,300 Couple taxed on full $64,000 of savings and other pension benefit plus $30,600 of Social Security benefit or $94,600 of $100,000 income (10) (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 25

26 Making the most of Social Security benefits Married couple B retires today at age 62 but defers receipt of Social Security until age 70 Need $100k in annual income to meet their needs Deferred commencement of $63k in Social Security benefits at age 70 $37K is taken from savings and other pension benefits to make up the difference Combined income formula calculates amount of Social Security benefit taxed as the smallest of : (1) 0.85 * $63,000 = $53,500 (2) 0.50 * $63, * [($37, * $63,000) - $44,000] = $52,325 (3) 0.50 * [($37, * $63,000) - $32,000] * [($37, * $63,000) - $44,000] = $26,825 Couple taxed on full $37,000 of savings and other pension benefit plus $26,825 of Social Security benefit or $63,825 of $100,000 income (10) (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 26

27 Making the most of Social Security benefits Married couple A chose to commence Social Security benefit immediately. They pay tax on almost 95% of total retirement income. Married couple B chose to defer Social Security benefit until age 70. They pay tax on almost 64% of total retirement income. In 2015, based on the tax rate for a married couple with income of $100,000, this could increase their after tax income almost $7,750. See Appendices for details on the overall impact this has on these married couples. 27

28 In summation For most people, Social Security will continue to represent 20% to 35% in replacement income. In a world of changing retirement models, it still guarantees lifetime income. Strong consideration should be given to delay commencing Social Security benefits. Doing so provides a significantly larger benefit and some longevity insurance. Understanding and appropriately using various ways married couples can integrate worker, spousal and survivor benefits can enhance the value of their Social Security benefit. Social Security is not taxed the same as IRA income. Choosing higher Social Security income and lower IRA withdrawals can reduce taxes. Future changes likely to Social Security. Stay tuned! 28

29 Appendices MARRIED COUPLE A Age Year IRA balance Withdrawal Additional Tax Age Year IRA balance Withdrawal Additional Tax $1,000,000 $64,000 $ $733,675 $64,000 $7, $992,160 $64,000 $ $702,106 $64,000 $7, $983,850 $64,000 $ $668,642 $64,000 $7, $975,041 $64,000 $ $633,171 $64,000 $7, $965,703 $64,000 $ $595,571 $64,000 $7, $955,805 $64,000 $ $555,715 $64,000 $7, $945,314 $64,000 $ $513,468 $64,000 $7, $934,192 $64,000 $ $468,686 $64,000 $7, $922,404 $64,000 $ $421,217 $64,000 $7, $909,908 $64,000 $7, $370,900 $64,000 $7, $888,913 $64,000 $7, $317,564 $64,000 $7, $866,657 $64,000 $7, $261,028 $64,000 $7, $843,067 $64,000 $7, $201,100 $64,000 $7, $818,061 $64,000 $7,750 sum of distributions: $1,664, $791,554 $64,000 $7,750 present value of distributions: $921, $763,458 $64,000 $7,750 Assumes 6% per annum interest rate Married couple A's tax rate is 25%. Between ages 62 and 70 married couple A is paying tax on approximately $5,000 less than married couple B. Thereafter, they are paying tax on about $31,000 of income more than married couple B. "Additional Tax" column estimates the amount of higher tax couple A is paying due to couple A's higher taxable income. This amount reduces the residual IRA balance. (10) (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 29

30 Appendices MARRIED COUPLE B Age Year IRA balance Withdrawal Additional Tax Age Year IRA balance Withdrawal Additional Tax $1,000,000 $100,000 $1, $460,298 $37,000 $ $952,750 $100,000 $1, $448,696 $37,000 $ $902,665 $100,000 $1, $436,397 $37,000 $ $849,575 $100,000 $1, $423,361 $37,000 $ $793,299 $100,000 $1, $409,543 $37,000 $ $733,647 $100,000 $1, $394,895 $37,000 $ $670,416 $100,000 $1, $379,369 $37,000 $ $603,391 $100,000 $1, $362,911 $37,000 $ $532,345 $37,000 $ $345,466 $37,000 $ $525,065 $37,000 $ $326,974 $37,000 $ $517,349 $37,000 $ $307,372 $37,000 $ $509,170 $37,000 $ $286,595 $37,000 $ $500,500 $37,000 $ $264,570 $37,000 $ $491,310 $37,000 $0 sum of distributions: $1,577, $481,569 $37,000 $0 present value of distributions: $947, $471,243 $37,000 $0 Assumes 6% per annum interest rate Married couple B's tax rate is 25%. Between ages 62 and 70 married couple B is paying tax on approximately $5,000 more than married couple A. Thereafter, they are paying tax on about $32,000 less than married couple A. "Additional Tax" column estimates the amount of higher tax couple B is paying due to couple B's higher taxable income. This amount reduces the residual IRA balance. (10) (10) Innovative strategies to help maximize Social Security benefits, James Mahaney, November 2012, Prudential Retirement 30

31 Disclaimers Retirement products and services are provided by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, a Prudential Financial company. Prudential Retirement is a Prudential Financial business. This information has been provided for informational purposes. This should not be construed as an offer of securities or products. All calculations are hypothetical in nature and should not be considered investment advice. Prudential Financial and its associates do not provide investment or legal advice for which you should contact your qualified professional Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol, Bring Your Challenges, and DC Optimization are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions worldwide 31