RETIREMENT PLANNING Keir Educational Resources

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1 RETIREMENT PLANNING 2015 Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH FAX Keir Educational Resources

2 TABLE OF CONTENTS Title Page Retirement Planning (Topics 44-52) Topic 44: Retirement Needs Analysis Topic 45: Social Security [Old-Age, Survivor, and Disability Insurance (OASDI)] Topic 46: Types of Retirement Plans Topic 47: Qualified Plan Rules and Options Topic 48: Other Tax-Advantaged Retirement Plans Topic 49: Regulatory Considerations Topic 50: Key Factors Affecting Plan Selection for Businesses Topic 51: Investment Considerations for Retirement Plans Topic 52: Distribution Rules, Alternatives, and Taxation Appendix Gordon Case Appendix 1 Roland Case Appendix 10 Loomis Company Case Appendix 17 Kramer Transportation Services, Inc. Case Appendix 25 Sparks Case Appendix 30 Lytle Case Appendix 37 Beals Case Appendix 42 Edmonds Case Appendix 51 Mcgee Case Appendix 69 Eastman Case Appendix 86 Harrison Case Appendix 98 Selected Facts and Figures Appendix Topic List Appendix 138 Glossary Glossary 1 Index Index Keir Educational Resources

3 Social Security [Old-Age, Survivor, and Disability Insurance (OASDI)] (Topic 45) CFP Board Student-Centered Learning Objectives (a) Provide an overview of the Social Security system, including the payroll taxes and benefits structure and advising clients in consideration of proposed program reforms. (b) Explain qualification requirements for Social Security benefits. (c) Explain the computation of the Average Indexed Monthly Earnings (AIME), the Primary Insurance Amount (PIA), disability, survivor and maximum family benefits. (d) Assist a client in selecting the optimal date to begin receiving Social Security benefits. (e) Explain the impact of the retirement earnings test, the windfall elimination and the government pension offset on benefits. (f) Describe the taxation of each type of Social Security benefits. Social Security [Old-Age, Survivor, and Disability Insurance (OASDI)] A. Paying into the system B. Eligibility and benefits 1) Retirement 2) Disability 3) Survivor 4) Family limitations C. How benefits are calculated D. Working after retirement E. Taxation of benefits Paying into the System Social Security benefits are paid from the 6.2% tax on each employee s wages (matched by employers) and the 12.4% tax on self-employment earnings. These FICA taxes are imposed on a maximum of $118,500 in wages for An additional 1.45% is paid by both employees and employers on wages for Medicare, and there is no limit on wages subject to this tax. Beginning in 2013, employees pay an additional.9% Medicare surtax on wages and self-employment income over $200,000 ($250,000 for joint returns; $125,000 for 2015 Keir Educational Resources

4 married taxpayers filing a separate return). The taxes do not accumulate in accounts with individual workers names on them; rather, they are counted in the general receipts of the U.S. government. To the extent that taxes exceed current benefit payments, the funds are used to buy U.S. Treasury bonds in a sort of trust fund. The benefits are currently guaranteed by the U.S. government out of future tax receipts. Some calculations show, however, that sometime in this century, benefit payments will exceed tax inflows, and the trust fund will be exhausted. Even with these uncertainties, a consideration of Social Security benefits is an important part of any retirement plan. Basic Provisions of OASDI Over 90% of U.S. workers are covered by Social Security and eligible to receive both retirement and disability benefits. The following table summarizes the coverage of Social Security: EXHIBIT 45 1 Workers Covered by OASDI Covered Not Covered Federal employees hired since 1984 Federal employees hired before 1984 U.S. armed forces Railroad employees Self-employed persons Family employment Employees of nonprofit organizations Ministers, members of religious orders, and Christian Science practitioners, only if claiming an exemption Hospital interns Student nurses Domestic workers Newspaper delivery persons under age 18 Farmers and agricultural workers Students working for a college or club Family Employment Rules The family employment rules state that there is no Social Security coverage for the following family employees: (1) A child under age 18 hired by a parent (not a corporation) (2) A child 18 to 21 years of age employed by a parent to perform work that is not in the parent s trade or business (e.g., cleaning the office) (3) A person employed by a spouse to perform work that is not in the spouse s trade or business (4) A parent employed by a child to perform work not in the child s trade or business 2015 Keir Educational Resources

5 Practice Question Which of the following persons is working in an employment covered by Social Security? A. Railroad employees B. A parent landscaping around a child s accounting office C. A student working at his or her college D. A member of the U.S. Coast Guard Answer: Railroad employees and students working at their college are not covered employments, and a parent working at a child s office is not covered if the work is not in the child s trade or business. Members of the U.S. armed forces are covered. The answer is D. Eligibility How Benefits Are Calculated Eligibility for all Social Security benefits is determined based on a credit system. To earn one credit, a worker must earn $1,220 in 2015 in covered wages or self-employment income. A worker can earn a maximum of 4 credits per year. Earnings not subject to selfemployment tax or FICA withholding do not count toward credits (e.g., net earnings from S corporations, rental income, wages paid to the children of a sole proprietor who are under 18, etc.). Workers born after 1929 are eligible for Social Security retirement benefits once they have earned 40 credits (10 years). Those born before 1929 need 1 less credit for each year they were born before The monthly benefit amount received upon retirement depends upon several factors, including the level of earnings on which FICA or self-employment taxes were paid during a client s working life, the age at which benefits start, and assumptions regarding inflation and average wage increases. The benefit amount is calculated as follows: First, the client s average indexed monthly earnings is calculated. This calculation requires the earnings for all the years the client was subject to FICA or self-employment taxes. The maximum to be considered in any given year is the Social Security maximum earnings on which FICA tax is paid for 2015, it is $118,500. The highest 35 years of earnings are then 2015 Keir Educational Resources

6 taken, and each year is indexed for inflation and then added together. This sum is divided by 420 (the number of months in 35 years) to get the average indexed monthly earnings. If a client has earnings for only 30 years, the sum of those earnings is still divided by 420. The average indexed monthly earnings (AIME) is multiplied by a reduced percentage to determine the benefit amount. For those retiring in, 2015 benefits are calculated as follows: If the AIME is less than $826, then the AIME x 90% = the monthly benefit amount. If the AIME is greater than $826 but less than $4,980, then $743 plus 32% of the amount over $826 = the monthly benefit amount. If the AIME is greater than $4,980, then $2,072 plus 15% of the amount over $4,980 = the monthly benefit amount. Primary Insurance Amount (PIA) Full Retirement Age (FRA) This calculation results in the PIA (primary insurance amount). While the percentages are projected to remain the same, the amounts at which they are applied will adjust with inflation and average wages. If a worker retires at full retirement age (also called normal retirement age), he or she will receive the full amount calculated as PIA, which is adjusted each year for changes in the Consumer Price Index (CPI). Full retirement age was 65 for many years but is currently increasing. For every year a client was born after 1937, up to 1942, full retirement age increases by two months over 65. Those born from 1943 to 1954 will receive full benefits at age 66. Those born after 1954 but before 1960 must add 2 months for every year after 1954 to age 66 to determine full retirement age. Under current law, full retirement age for those born in 1960 and later will be 67. Since Congress has been under pressure to extend the financial viability of Social Security without raising taxes, changes to the full retirement age were almost inevitable Keir Educational Resources

7 Year Born Full Retirement Age (based on birth month) 1937 or earlier plus 2 months for each year born after plus 2 months for each year born after or later 67 Early Retirement Retirement benefits under Social Security can begin as early as age 62, no matter what a worker s full retirement age is. Benefits are reduced by 5/9 of a percent for every month that a worker begins receiving benefits before full retirement age for the first 36 months prior to retirement. For a spouse not caring for a child, who elects early retirement, the reduction is 25/36 of a percent for each of the first 36 months. The benefits are reduced by 5/12 of a percent for every month in excess of 36 months a worker or spouse begins receiving benefits before full retirement age. Therefore, if a worker elects to receive benefits 3 years before FRA, then the worker will receive 80% of the primary insurance amount, as figured above (36 x 5/9 = 20% reduction). If a worker elects to begin benefits 4 years early, the reduction is 25%; if 5 years early, the reduction is 30%. Early retirement may also make the AIME lower because earnings during the years between ages 62 and 65 will generally be among the highest of an employee s career and would be used in the 35 highest years average (rather than earlier, lower-earning years). When considering early retirement, a planner should include the effect of that decision on Social Security benefits. Delayed Retirement Delaying the start of benefits past the client s normal retirement age will increase the primary insurance amount. The following chart shows, by year of birth, the increase in benefits for waiting one year after the normal retirement age to start benefits. (The increase is only calculated for delaying up to age 70; delays past 2015 Keir Educational Resources

8 age 70 will not continue to increase benefits.) Increase for a One- Year of Birth Year Delay % % % % % % % % % % 1943 and after 8.0% This increase is in addition to any cost-of-living increases that are applied to all benefits in general. Note: A program called Anypia can be downloaded from the Social Security Administration s Web site ( oact/anypia/anypia.html), and this program will calculate a client s likely future benefits, given his or her earnings, age, and other assumptions. The program allows the user to change any of the parameters and recalculate the benefits. A client can also request a Personal Earnings and Benefits Estimate Statement from the Web site or by calling the local Social Security office Keir Educational Resources

9 Application Questions 1. If Mr. and Mrs. King have an AGI of $42,000 excluding Social Security, and have $3,000 in tax-exempt interest, and they receive $9,000 in Social Security benefits, how much of the Social Security benefits will be included in taxable income if they file jointly? A. $9,000 B. $7,650 C. $5,500 D. $4, Which of the following is not a factor in calculating the amount of Social Security benefits to be received? A. Age that benefit payments begin B. Wages received over $15,720 (in 2015) for a retiree age 64 C. Whether a worker was an employee or self-employed D. Earnings over the worker s lifetime 3. Which of the following statements concerning reduction of Social Security retirement benefits is correct if full retirement age is 66? A. Benefits are reduced $1 for every $3 earned over $15,720 this year for ages 62 to 65. B. Benefits are reduced only for earnings after age 66. C. Benefits are reduced 5/9 of 1% per month for early retirement between ages 59½ to 66. D. Benefits are not reduced at any age for a spouse caring for a worker s child under age Which of the following relatives is (are) eligible for the $255 lump-sum death benefit under OASDI? (1) A spouse living with the deceased at the time of death (2) A divorced spouse who was married to the deceased worker for 12 years (3) A deceased worker s dependent 17-year-old son (4) A deceased worker s 22-year-old daughter and only survivor A. (1) and (2) only B. (1), (2), and (3) only C. (2), (3), and (4) only D. (4) only 2015 Keir Educational Resources

10 5. For an insured worker who was born in 1960 and wants to retire at age 65, under current law, how much will his or her primary insurance amount be reduced? A. 13.3% B. 15.3% C. 20.0% D. 25.0% 6. Which of the following statements are correct with regard to retirement planning for Social Security? (1) Retiring at age 55 after 30 years of work will make a client ineligible for Social Security benefits at any time. (2) Only amounts up to the established Social Security wage base for each year are used in calculating benefits. (3) The percent of average monthly earnings that is paid as retirement benefits depends on the level of income. (4) Retirement benefits are not available to spouses of covered workers unless the spouses have Social Security earnings themselves. A. (1) and (2) only B. (1) and (3) only C. (2) and (3) only D. (2), (3), and (4) only E. (1), (2), (3), and (4) 7. Which of the following statements are correct concerning the effect of different retirement dates on Social Security benefits? (1) Retirement benefits that begin at full retirement age may be reduced if the client continues to have earnings. (2) Withdrawals from other qualified retirement plans will reduce Social Security benefits before age 70. (3) If a client s earnings at age 63 are higher (after considering inflation) than those when he or she was 33, then each additional year worked will increase the AIME. (4) A client born in 1944 could increase calculated benefits by 32% by waiting until age 70 to receive Social Security benefits. A. (1) and (2) only B. (1) and (3) only C. (2) and (3) only D. (3) and (4) only E. (1), (2), (3), and (4) 2015 Keir Educational Resources

11 Answers and Explanations 1. B is the answer. Combined income (formerly called provisional income) is $49,500 ($42,000 + $3,000 + $9,000/2) and thus is over the threshold ($44,000 for joint filers) by $5, % of the amount over the threshold is $4,675, which is added to the lesser of $9,000/2 = $4,500 or $6,000 (for joint filers). Using the $4,500, and adding it to $4,675, results in a sum of $9,175. This is compared with 85% x $9,000 = $7,650. The lower amount ($7,650) is the amount of taxable Social Security benefits. 2. C is the answer. Employees and those self-employed pay Social Security tax on the same basis and are credited with earnings in the same way. Benefits are determined by the age of the recipient (those under full retirement age receive reduced benefits, and those over full retirement age receive a higher benefit) and can be reduced by earnings over the set thresholds for those under full retirement age and by the AIME, or average index monthly earnings, over the highestpaid 35 years in a worker s lifetime. 3. D is the answer. Benefits are not reduced at any age for a spouse caring for a worker s child under age 16. Benefits are reduced $1 for every $2 earned over $15,720 (2015) at ages 62 to 65. Benefits are not reduced for earnings after normal retirement age, but are reduced at age 66, until the month of normal retirement age, $1 for every $3 above $41,880 ($3,490/month) in B is the answer. The lump-sum death benefit is payable to a spouse who was living with the deceased at the time of death. If no spouse was living with the deceased worker, then a spouse or dependent child eligible to receive Social Security benefits based on the worker s earnings for the month of the worker s death can receive the lump-sum benefit. A 22-year-old child is not eligible for benefits. 5. A is the answer. Benefits are reduced by 5/9% for each month prior to full retirement age that a person begins benefits. For someone born in 1960, full retirement age is 67, and retirement at age 65 would be 24 months early. The reduction would be 24 x 5/9%, or 13.3%. 6. C is the answer. Once a person has earned the 40 credits needed to be fully insured under Social Security, the person will remain fully insured, regardless of how long they may go without working. The AIME is reduced because of the fewer years of earnings to be averaged over the assumed 35 years of work life, but the benefits will still be paid. AIME uses the amount of yearly earnings or the Social Security base, whichever is less, to calculate the highest 35 years of earnings. AIME is multiplied by a percent to determine the PIA. For 2015, the first $826 of AIME is multiplied by 90%, while earnings in excess of that are only multiplied by 32% or 15%. Spouses of covered workers are entitled to half of the worker s benefits, whether or not the spouses have earnings of their own. 7. D is the answer. Only earnings from wages or businesses have the potential to reduce Social Security benefits received before retirement age. Other retirement plan withdrawals, interest, dividends, and rents are some of the types of income that will not affect Social Security benefits Keir Educational Resources

12 Because the AIME is calculated using the 35 highest-paid years, dropping an earlier year with lower earnings and replacing that year with higher earnings will increase the AIME slightly. For clients born in 1944, full retirement age is 66, and the percent by which benefits are increased for one year of delay is 8%. For those clients, delaying retirement until age 70 (or 4 more years) results in an increase of 32% in yearly benefits Keir Educational Resources

13 2015 Keir Educational Resources