Using Cash Value Life Insurance for Retirement Savings

Using Cash Value Life Insurance for Retirement Savings

Presented by Jared Daniel of Wealth Guardian Group

What is using cash value life insurance for retirement savings?

One of the more popular uses for cash value life insurance is to save for retirement. Cash value life insurance refers to a wide variety of insurance policies that provide both a death benefit and the potential accumulation of cash value over a period of time. Cash value life insurance can range from a traditional level premium whole life policy to a single premium whole life policy to a universal life policy to a variable life insurance policy or a variable universal life policy. In today's insurance marketplace, there are a wide variety of cash value life insurance policies that a consumer can buy. These types of insurance policies are in contrast to a term life insurance policy in which the insured makes a series of premium payments and the beneficiaries collect the death benefit if the insured dies while the policy is still in effect. There is no buildup of cash value with a term life policy.

Many people use a cash value life insurance policy to save for their retirement and to provide a death benefit to their beneficiaries. In very rare instances, companies may offer their employees an option under their retirement plan to purchase life insurance. Under a qualified retirement plan, amounts contributed to the plan by the employer will be tax deductible. Any increases in the cash value part of the policy due to investment or interest gains will be tax deferred until the money is withdrawn from the policy. Some people will also use a cash value life insurance policy as a supplement to a qualified retirement plan. If you work for a company that does not offer a qualified retirement plan (or does not offer a life insurance option in an existing plan) or if you have already contributed the maximum amount to your qualified retirement plan, a cash value insurance policy can offer some of the tax benefits of a qualified retirement plan. Although the payment of the insurance premiums is not tax deductible, any increase in the cash value of the insurance policy due to investment gains is not taxed until you begin to withdraw the money after you retire. The cash value grows tax deferred (like an annuity). Furthermore, the withdrawals may not be taxable if you utilize the tax-favored withdrawal provisions cash value policies offer.

Caution:         Some cash value life insurance policies do not offer a guaranteed return (e.g., variable universal life). These policies may gain or lose value based on the performance of the underlying investments. Variable life and variable universal life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy.

Caution:         Any guarantees associated with payment of death benefits, income options, or rates of return are based on the claims-paying ability of the insurer. Policy loans and withdrawals will reduce the policy's cash value and death benefit.

When is a good time to use cash value life insurance for retirement savings?

To provide family members with a death benefit and to save for retirement

Use a cash value life insurance policy for retirement savings if your goal is to provide life insurance for your family, as well as save for retirement in one combined effort. A cash value life insurance policy consists of two parts: a life insurance part and an investment part. Although there is only one premium for the total insurance policy, the premium paid each year is divided between the payment for the insurance and the payment for the investment savings.

Life insurance

Consider purchasing a cash value policy if you have a need for life insurance. To determine this need, consider the following factors. First, are there dependents (e.g., a spouse, children or elderly parents) who rely on your income to maintain their standards of living? If so, an appropriate life insurance policy can provide for your dependents in the event of your premature death. Second, if you are a non-income earning spouse, do you provide services that your spouse would otherwise have to pay for (e.g., child care, housekeeping, cooking, etc.)? Then you may need life insurance as well. Third, do you have such a large estate that substantial estate taxes will be incurred upon your death? Life insurance may be an excellent way to provide this liquidity to your heirs.

What are the strengths of using cash value life insurance for retirement savings?

Protection from financial uncertainty

One of the main strengths of using cash value life insurance for retirement savings is to protect your family from financial uncertainty in the event of your premature death. Saving for retirement by buying mutual funds or Treasury bills or by simply investing your money in a savings account at the bank, is one approach, but then if you need life insurance you will have to buy a separate (perhaps term) policy. By purchasing a cash value life insurance policy, allows you to combine life insurance protection for your family with an investment component for your retirement. However, the cash value portion of life insurance policy is not like a savings account. It is not backed by the Federal government (FDIC insured), and it may experience gains or losses based on the performance of the underlying investment. Also, cash value life insurance may impose charges and expenses that can reduce your cash value.

Premiums may be tax deductible

If your employer offers the option to purchase life insurance through the company's qualified retirement plan, then, within limits, your (and your company's) tax-deductible contributions into the retirement plan may be used to purchase the insurance policy. Thus, using a cash value life insurance policy to save for your retirement can be an excellent way to buy a substantial life insurance policy on your life and save for your retirement, all for a discounted cost.

Caution:         Very few companies offer the option to purchase life insurance through their qualified retirement plans. There are complicated rules and limits that must be followed to offer life insurance through a qualified plan. Furthermore, there is extensive paperwork that must be completed. Many companies simply do not want to go through the effort to offer this option to their employees. Furthermore, many types of qualified retirement plans (such as IRAs and savings incentive match plans for employees) do not allow life insurance to be purchased through the plan.

Policy values grow tax deferred

Another benefit to using cash value life insurance to save for your retirement is that the cash value part of the policy grows tax deferred. In this respect, a cash value life insurance policy is similar to an annuity. The cash value portion of the policy grows tax deferred until you begin to withdraw the funds or surrender the policy. Because the cash value grows tax deferred, some people will use a cash value life insurance policy as a supplement to a qualified retirement plan. If your company does not offer a qualified retirement plan or if you have already contributed the maximum amount to your qualified plan, then purchasing a cash value life insurance policy will give you some of the tax benefits of a qualified retirement plan. Although the premiums will not be tax deductible, the increase in the cash value due to interest and investment gains will not be taxed during the accumulation years.

Caution:         The current cost of the insurance protection of a life insurance policy held in a qualified plan is taxable as income to the employee.

Cash value may be withdrawn

You may be able to withdraw some of the cash value from your life insurance policy (depending on the type of policy). The money can be withdrawn at any time, subject to the terms of the policy. As long as you maintain enough cash value in the policy, you can withdraw the cash from the policy and still keep the life insurance in effect to provide a death benefit for your family.

Cash value can be borrowed against

You can also borrow against the cash value in your insurance policy. The cash value that has built up in the policy is the collateral for the loan. The interest rate on the loan is determined in advance and is often below rates offered by banks.

Caution:         If you die before the loan is fully paid off, the amount of your death benefit is reduced by the amount of the outstanding loan (including interest). Furthermore, the policy must remain in force to maintain the favorable tax treatment of the loan.

What are the tradeoffs of using cash value life insurance to save for your retirement?

The applicant must be insurable

An applicant must be deemed "insurable" by an insurance company in order for the insurance company to issue an insurance policy on your life. There are several factors that affect insurability; the two most important are age and medical history. The older you are and the worse your medical history, the more difficult and/or costly it will be to obtain life insurance. For example, a 45-year-old person in perfect health will pay substantially less for a comparable amount of insurance than a 65-year-old person who has already suffered a heart attack.

Cash value life insurance premiums are more expensive than term life premiums

Another tradeoff to using a cash value life insurance policy to save for retirement is that the premiums for a cash value policy are substantially more expensive than for a comparable amount of term insurance. The premiums are more expensive for a cash value policy because you are paying for both an insurance element and an investment element. With a term policy, you are simply paying for the insurance element (the death benefit). For example, a 40-year-old man in good health might pay $600 per year for a 10-year level premium $500,000 term life insurance policy. That same person might pay $6,000 per year for a cash value policy with the same death benefit. There may also be higher costs associated with a cash value life insurance policy (e.g., policy fees, higher commissions, premium expense charges, and surrender charges).

Purchasing power may be limited

The insurance company may limit the amount of insurance that an individual can purchase. If an applicant wants to purchase a very large insurance policy, the insurance company may require a justification of that amount of insurance (i.e., prove why that amount is necessary). The insurance company may consider factors such as income and assets. For example, if Ted earns $50,000 per year, the insurance company may not be willing to issue a policy with a $5 million death benefit on his life.

Cash value contributions may be limited

Because the cash value grows tax deferred, the federal government has passed laws and issued regulations limiting the amount of money that can be invested in these policies. If these limits are exceeded, the policy may not be treated as a life insurance policy for federal income tax purposes. This is a very technical area. Consult a tax planning professional more information on the limits on cash value life insurance policies.

Modified Endowment Contract (MEC) rules also limit size of cash value policies

Under federal law, if your premium payments into a cash value life insurance policy exceed certain limits, the policy is then permanently classified as a modified endowment contract (MEC), and is subject to special taxation rules. Under these special rules, distributions, including policy loans, are taxable as income to the extent the policy cash value immediately prior to the distribution or loan exceeds the basis in the contract. A penalty may also apply to taxable distributions and loans. Consult a tax professional.

What are the tax implications?

Premium payments may be deductible

If your company offers the option to purchase life insurance through its qualified retirement plan, then, within limits, your tax-deductible contributions into the plan (and/or your company's contributions) can be used to buy the life insurance policy. Not many companies offer their employees the option to purchase life insurance through their qualified retirement plan. If you do not purchase the insurance policy through a qualified retirement plan, then the premiums will not be tax deductible.

Cash withdrawals in excess of basis are taxable income

When you begin to withdraw cash from a cash value life insurance policy (although only certain types of cash value policies allow withdrawals), the amount of withdrawals up to the basis in the policy will be tax free (the basis is the amount of premiums paid into the policy net of any previous dividends and tax-free withdrawals). Any withdrawals in excess of the basis will be taxed as income. If the policy is classified as a modified endowment contract, then withdrawals will be treated as first coming from earnings and, as a result, will be subject to income tax.

Policy loans are usually not taxable

If you take out a loan against the cash value of your insurance policy, the amount of the loan is not taxable (except in the case of a modified endowment contract). This result is the case even if the loan is larger than the amount of the premiums you have paid in.

Caution:         Such a loan is not taxed only as long as the policy is in place.

Interest on policy loans are usually not tax-deductible

The interest on any loans taken out against the cash value of your life insurance is usually not deductible.

Surrender of policy may result in taxable gain

Like a policy withdrawal, if you surrender your cash value life insurance policy, any gain on the policy may be subject to federal (and possibly state) income tax. The gain on the surrender of a cash value policy is the difference between the net cash value and loan forgiveness amounts and your basis in the policy. Your basis is the total premiums you paid in cash, minus any policy dividends and tax-free withdrawals that you made.

Death benefits are usually not subject to federal income tax

Whoever receives the death benefits from your insurance policy (at the time of your death) usually does not have to include those proceeds in income for federal income tax purposes. One exception to this rule is if the insurance policy has been sold from one policyowner to another, subjecting it to the transfer-for-value rule. Another exception is that with respect to cash value life insurance held in a qualified retirement plan, a portion of the death proceeds equal to the cash value of the policy immediately prior to the insured employee's death will be treated as a plan benefit (not as life insurance proceeds) and therefore will be subject to income tax when distributed to a beneficiary.

Gift Tax

Policy proceeds are usually not considered a gift to beneficiary

The payment of death benefits to a beneficiary from a cash value life insurance policy on your life is usually not considered a taxable gift from you, although it generally is a transfer that is subject to estate tax. One situation where the payment of an insurance death benefit may be subject to the gift tax is when the owner, insured, and beneficiary are three different individuals--for example, when the husband is the owner of the life insurance policy, the wife is the insured, and a child is the beneficiary of the policy. Upon the death of the wife, the husband is considered to have made a gift of the insurance proceeds to the child. This gift may be subject to the gift tax.

Payment of policy premiums are generally not subject to gift tax

If you pay the premiums for an insurance policy on your own life, the payment of the premiums is not considered to be a taxable gift to the beneficiary of the policy. For example, Janet pays $5,000 per year in premiums for a $300,000 cash value insurance policy on her life. Her only child is the named beneficiary on the policy. The payment of this $5,000 premium is not a taxable gift from Janet to her child. However, if someone else pays the premiums for a policy that Janet owns, then the payment of those premiums is usually considered to be a taxable gift. The gift tax may apply if the annual premiums exceed the annual gift tax exclusion amount. In general, the payment of life insurance premiums made on behalf of another will qualify for the annual exclusion from the gift tax.

Estate Tax

Insurance proceeds may be included in your taxable estate

If an insured hold any incidents of ownership in an insurance policy or their estate is the beneficiary of the policy, the proceeds from that insurance policy will be included in the taxable estate. Furthermore, if the insured makes a gift of an insurance policy within three years of his or her death, then the proceeds from that policy will be pulled back into the taxable estate. Incidents of ownership include the right to change the beneficiary, the right to take out policy loans, and the right to surrender the policy for cash, among other things.

Jared Daniel may be reached at www.WealthGuardianGroup.com or our Facebook page.

IMPORTANT DISCLOSURESBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.

Will You Outlive Your Money

Will You Outlive Your Money?

Presented by Jared Daniel of Wealth Guardian Group

Will you outlive your money?

Before you retire, take the time to figure out just how much money you'll need for retirement. One of the biggest concerns for retirees is whether their retirement savings will last the rest of their lives-- will they run out of money? Social Security is not the guaranteed source of retirement income it once was, and people generally don't want to depend on public assistance or their children during their retirement years. Whether you might run out of money hinges upon several factors; how much money you've saved, how long you need your savings to last, and how quickly you spend your money, to name a few. You'll be better off if you can tackle these issues before retirement by maximizing your retirement nest egg. But, if you are entering retirement and you still have concerns about making your savings last, there are several steps you can take even at this late date. The following are tips and ideas to help make sure you don't outlive your money.

Tips to help make your savings last longer

You may be able to stretch your retirement savings by adjusting your spending habits. You might be able to get by with only minor changes to your spending habits, but if your retirement savings are far below your projected needs, drastic changes may be necessary. Saving even a little money can really add up if you do it consistently and earn a reasonable rate of return.

Make major changes to your spending patterns

If you have major concerns about running out of money, you may need to change your spending patterns drastically in order to make your savings last. The following are some suggested changes you may choose to implement:

·         Consolidate any outstanding loans to reduce your interest rate or monthly payment. Consider using home equity financing for this purpose.

·         If your home mortgage is paid in full, weigh the pros and cons of a reverse mortgage to increase your cash flow.

·         Reduce your housing expenses by moving to a less expensive home or apartment.

·         If you are still paying off your home mortgage, consider refinancing your mortgage if interest rates have dropped since you took the loan.

·         Sell your second car, especially if it is only used occasionally.

·         Shop around for less expensive insurance. You'd be amazed how much you can save in a year (and even more over a period of years) by switching to insurance policies that have lower premiums, but that still provide the coverage you need. Life and health insurance are the two areas where you probably stand to save the most, since premiums can go up dramatically with age and declining health. Consult your insurance professional.

·         Have your child enroll in or transfer to a less expensive college (a state university as opposed to a private one, for example). This can be a particularly good idea if the cheaper college has a strong reputation and can provide a quality education. You could save significantly over the course of just two or three years.

Make minor changes to your spending patterns

Minor changes can also make a difference. You'd be surprised how quickly your savings add up when you implement a written budget and make several small changes to your spending patterns. If you have only minor concerns about making your retirement savings last, small changes to your spending habits may be enough to correct this problem. The following are several ideas you might consider when adjusting your spending patterns:

·         Buy only the auto and homeowners insurance you really need. For example, consider canceling collision insurance on an older vehicle and self-insure instead. This may not save you a bundle, but every little bit helps. Of course, if you do have an accident, the amount you saved on your premium could be wiped out very quickly.

·         Shop for the best interest rate whenever you need a loan.

·         Switch to a lower interest credit card. Transfer your balances from higher interest cards and then cancel the old accounts.

·         Eat dinner at home, and carry "brown-bag" lunches instead of eating out.

·         Consider buying a well-maintained used car instead of a new car.

·         Subscribe to the magazines and newspapers you read instead of paying full price at the newsstand.

·         Where possible, cut down on utility costs and other household expenses.

·         Get books and movies from your local library instead of buying or renting them.

·         Plan your expenditures and avoid impulse buying.

Manage IRA distributions carefully

If you're trying to stretch your savings, you'll want to withdraw money from your IRA as slowly as possible. Not only will this conserve the principal balance, but it will also give your IRA funds the opportunity to continue growing tax deferred during your retirement years. However, bear in mind that you must start taking required minimum distributions (RMDs) from traditional IRAs (but not Roth IRAs) after age 70½.

Use caution when spending down your investment principal

Don't assume you'll be able to live on the earnings from your investment portfolio and your retirement account for the rest of your life. At some point, you will probably have to start drawing on the principal. You'll want to be careful not to spend too much too soon. This can be a great temptation particularly early in your retirement, because the tendency is to travel extensively and buy the things you couldn't afford during your working years. A good guideline is to make sure you don't spend more than 5 percent of your principal during the first five years of retirement. If you whittle away your principal too quickly, you won't be able to earn enough on the remaining principal to carry you through the later years.

Portfolio review

Your investment portfolio will likely be one of your major sources of retirement income. As such, it is important to make sure that your level of risk, your choice of investment vehicles, and your asset allocation are appropriate considering your long-term objectives. While you don't want to lose your investment principal, you also don't want to lose out to inflation. A review of your investment portfolio is essential in determining whether your money will last.

Continue to invest for growth

Traditional wisdom holds that retirees should value the safety of their principal above all else. For this reason, some people totally shift their investment portfolio to fixed-income investments, such as bonds and money market accounts, as they approach retirement. The problem with this approach is that it completely ignores the effects of inflation. You will actually lose money if the return on your investments does not keep up with inflation. The allocation of your portfolio should generally become progressively more conservative as you grow older, but it is wise to consider maintaining at least a portion of your portfolio in growth investments. Many financial professionals recommend that you follow this simple rule of thumb: The percentage of stocks or stock mutual funds in your portfolio should equal approximately 100 percent minus your age. So, for example, at age 60 your portfolio should contain 40 percent stocks and stock funds (100% - 60% = 40%). Obviously, you should adjust this rule according to your risk tolerance and other personal factors.

Basic rules of investment still apply during retirement

Although you will undoubtedly make changes to your investment portfolio as you reach retirement age, you should still bear in mind the basic rules of investing. Diversification and asset allocation remain important as you make the transition from accumulation to utilization.

Laddering investments

Laddering investments is a method of controlling your investments to avoid having them all mature at the same time. The principle of laddering is simple: Stagger the maturity dates of the associated deposits or investments so that they mature in different time periods. You can apply laddering to any type of deposit, loan, or security having a specified maturity date, such as bonds.

Laddering can reduce interest rate risk

Interest rates rise and fall in response to many factors. Consequently, they are largely unpredictable. Whether you apply laddering to a cash reserve or use it in portfolio investing, minimizing interest rate risk is one of its most important benefits. Laddering investments minimizes interest rate risk because you will be investing at various times and under various interest rates. Thus, you are unlikely to be consistently locked into lower-than-market interest rates.

A single large deposit or investment that matures during an interest rate slump will leave you with two undesirable choices regarding reinvestment. You can hold the money in a low-interest savings account until rates improve or roll it over at the now low rate. However, a later rebound of interest rates can catch you locked into the prior low rate for an extended period. Breaking your investment into smaller pieces and laddering maturity dates allows you to avoid this situation.

How do you do it?

When you first begin your laddering strategy, you will need to acquire several term deposits (e.g., certificates of deposit) or securities with specified maturity dates. Initially, your individual investments should have terms of varying lengths, and you should intend to hold them until maturity. This will set up your staggered maturity dates. For example, you might purchase three separate certificates of deposit--one with a three-month term, one with a six-month term, and one with a nine-month term. When you reinvest as your CDs mature, your new investments should each be of the same length to perpetuate the staggering, or laddering, of maturity dates. Keep your laddering strategy intact by promptly redepositing each maturing investment for a new term.

Long-term care insurance

A catastrophic injury or debilitating disease that requires you to enter a nursing home can destroy your best-laid financial plans. You will need to decide whether to take out a long-term care insurance policy that may cover nursing home care, home health care, adult day care, respite care, and residential care. If you decide to purchase such a policy, you'll need to choose the best time to do so. Typically, unless you have a chronic condition that makes you more likely to require long-term care, there is generally no reason to begin thinking about this issue before age 50. Usually, there is no reason to purchase such a policy before age 60.

Won't Medicare pay for any long-term care expenses you might incur?

Contrary to popular belief, Medicare will not pay for most long-term care expenses, and neither will any health insurance you may have through your employer. Medicare benefits are only available if you enter a nursing home within 30 days after a hospital stay of three days or more. Even then, Medicare typically will only provide full coverage for 20 days of skilled nursing home care in Medicare-approved facilities. After 20 days, Medicare will cover part of the cost of care. You will pay $157.50 per day in 2015, and Medicare will cover the rest through day 100. No further coverage is available after 100 days.

What about Medicaid?

Medicaid is sponsored jointly by federal and state governments. Each state's Medicaid program is required to provide certain minimum medical benefits to qualified persons, including inpatient hospital services, nursing home care, and physicians' services. States also have the option of providing additional services. All states require proof of financial need. However, each state has different rules regarding benefits and eligibility, so it is essential that you understand your state's Medicaid program before you decide that Medicaid will provide adequate long-term care coverage.

How much does long-term care insurance cost?

Unfortunately, long-term care insurance can be quite expensive. If you begin coverage when you are younger, premiums will be more reasonable, but you will likely be paying for the insurance for a much longer period of time. The cost of LTCI will vary depending on your age, the benefits, and the insurer you choose.

Jared Daniel may be reached at www.WealthGuardianGroup.com or our Facebook page.

IMPORTANT DISCLOSURESBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.

Planning for Earned Income in Retirement

Planning for Earned Income in Retirement

Presented by Jared Daniel of Wealth Guardian Group

What is it?

         

If you're like a lot of people, retirement won't be the world of gardening, golfing, traveling, and tennis you once envisioned. Rather, retirement will mean relaxing and working. Maybe you've retired from your “regular" job and started a business, or perhaps you want to work part-time just to stay busy. However, if you work after you start receiving Social Security retirement benefits, your earnings may affect the amount of your benefit check.

                                   

How your earnings affect your benefit

Your earnings in retirement may increase your retirement benefit

                  

Your monthly Social Security retirement benefit is based on your lifetime earnings. When you become entitled to retirement benefits at age 62, the Social Security Administration (SSA) calculates your primary insurance amount (PIA) upon which your retirement benefit will be based. Later, your PIA will be recalculated annually if you have had any earnings that might substantially increase your benefit. So if you continue to work after you start receiving retirement benefits, these earnings may eventually increase your PIA and thus your retirement benefit.

                                   

Your earnings in retirement may decrease your retirement benefit

                            

If you earn income over a certain limit by working after you begin receiving retirement benefits, your benefit may be reduced proportionately. This limit, known as the retirement earnings test exempt amount, affects only beneficiaries under normal retirement age. The benefit reduction is based on your annual earnings and is not permanent; your monthly benefit is reduced starting in January of the year following the year you had excess earnings and will be reduced until the excess earnings are used up.

                                   

Example(s):   Emily is entitled to a Social Security retirement benefit of $800. When she was 64, her annual earnings exceeded the retirement earnings test exempt amount, so her benefit was reduced by $600. Consequently, in January of the following year, she received only a $200 monthly benefit check ($800 minus $600 equals $200). However, in February, she again received an $800 monthly benefit check.

                                               

Tip:     If your monthly benefit is reduced in the short term due to your earnings, you'll receive a higher monthly benefit later. That's because the SSA recalculates your benefit when you reach full retirement age, and omits the months in which your benefit was reduced.

                                               

How much is the retirement earnings test exempt amount?       

                   

In 2015, the annual exempt amount is $15,720 ($15,480 in 2014) for beneficiaries under normal (full) retirement age. However, in the year you reach full retirement age, a different limit applies. The limit in 2015 is $41,880 ($41,400 in 2014), which applies to earnings up to, but not including, the month you reach normal retirement age.

                       

How much benefit is withheld if you exceed the annual earnings limit?

If you're under normal retirement age, $1 in benefits is withheld for every $2 of earnings in excess of the annual exempt amount.                     

Example(s):   Ida was a self-employed potato farmer. After she began receiving Social Security retirement benefits at age 62, she continued to sell potatoes at her produce stand outside of Boise. Since she exceeded the annual retirement earnings test exempt amount by $380, $190 was withheld from her benefit check the following January.

                                               

In the year you reach normal retirement age, $1 in benefits is withheld for every $3 of earnings in excess of the special exempt amount that applies that year, but only counting money earned before the month you reach normal retirement age.

                                   

Example(s):   In the year that Ida reached normal retirement age, she earned $3,200 more than the special earnings limit that applies in that year. However, she earned $500 of that after she had reached normal retirement age, so that amount wasn't counted in calculating how much benefit would be withheld. Instead, the remaining $2,700 was used in the calculation, and $900 was withheld from Ida's benefit ($1 for every $3 in excess of the earnings limit).

                                   

What kinds of earnings may affect your benefit?

         

Earnings that might reduce your benefit

                  

·         Wages you earned as an employee (counted for the taxable year they're earned)

·         Net earnings from self-employment (usually counted in the year earnings are received)

·         Other types of work-related income, such as bonuses, commissions, and fees

Earnings that won't reduce your benefit

                            

·         Pensions and retirement pay            

·         Workers' compensation and unemployment compensation benefits

·         Prize winnings from contests, unless part of a salesperson's wage structure, or entering contests is your "business"

·         Tips that are less than $20 a month

·         Payments from individual retirement accounts (IRAs) and Keogh plans

·         Investment income

·         Income earned in or after the month you reach normal retirement age                   

Other types of earnings may affect your benefit. If you have additional questions about how the Social Security Administration defines earnings, contact the SSA at (800) 772-1213.

                                   

Which of your benefits may be affected by excess earnings?

                   

Your own retirement benefit

                   

Your Social Security retirement benefit may be reduced if you earn income over the retirement earnings test exempt amount.  

                                   

Benefits paid to your spouse or child

                            

If you have retired and your spouse and/or child receives benefits based on your Social Security record, any excess earnings you have may reduce their benefits. In addition, any excess earnings they have may reduce their own benefits but not your benefit.

                                   

Example(s):   Bill is 63 and receives a Social Security retirement benefit. His wife Betty, who is also 63, receives a retirement benefit based on Bill's earnings that is equal to 50 percent of Bill's benefit. If Bill earns $200 over the retirement earnings test exempt amount, his benefit is reduced by $100 ($200 divided by 2) the following January. Betty's benefit is reduced by 50 percent of that amount, or $50.

                                               

However, assume that Betty also works and earns $200 over the retirement earnings test exempt amount. Her benefit will be reduced by $100 ($200 divided by 2). Her benefit is reduced an additional $50 by Bill's excess earnings. Bill's benefit, however, is reduced by $100 because of his own excess earnings but is not affected by Betty's excess earnings.

                                               

Benefits paid to your survivors

If you die and a member of your family receives a survivor's benefit, that benefit may be reduced if the family member earns money in excess of the retirement test exempt amount.

                                   

Example(s):   When Bill dies, Betty, his widow, begins receiving survivor's benefits based on Bill's Social Security record. Since she earns $200 more than the exempt amount that year, Betty's survivor's benefit of $825 is reduced by $100 in January of the following year.

                                               

The earnings test is different in the first year of retirement

                   

Earnings from an employer

                            

In the first year of retirement, the earnings test is applied differently than in later years. Normally, the earnings test is based on the amount of income you earned annually; however, in the first year of retirement, the earnings test can be based on the amount of income you earned monthly, if that would benefit you. You can receive a full Social Security benefit check for any whole month in which your earnings don't exceed 1/12th of the annual exempt amount.

                                   

Example(s):   Caleb retired on July 31 at age 62. From January through July of that year, he earned $40,000. After he retired, he began working part-time and earned only $300 a month from August to December (each month, less than the monthly earnings exempt amount). Thus, even though his annual earnings during the year he retired greatly exceeded the annual earnings exempt amount, Caleb's benefit check was not reduced the following year.

                                               

Earnings from self-employment

                            

If you're self-employed, the SSA also considers whether you perform substantial services in your business. You will receive full benefits for any month you're not substantially self-employed. In general, you're considered to be substantially self-employed if you worked as a self-employed person more than 45 hours in one month. If you work less than 15 hours in one month, you will not be considered substantially self- employed, and you probably will receive your full retirement benefit for that month. If you work between 15 hours and 45 hours a month, you may or may not be considered substantially self-employed by the SSA, and your retirement benefit may be affected.

                                   

How you can keep your post-retirement earnings from exceeding the earnings exempt amount

         

Time your post-retirement earnings

                   

If you expect you will have substantial earnings after you retire and you have not yet reached normal retirement age, you may be able to time your post-retirement earnings to prevent withholding of all or part of your Social Security retirement benefit.

                                   

Create a self-employment loss

                            

If you're self-employed, you may be able to generate a self-employment loss to offset excess self-employment income.

                                   

Incorporate a sole proprietorship

                            

If you incorporate a sole proprietorship as an S corporation, you may be able to reduce your self-employment earnings by receiving profit distributions that will not be considered self-employment income for the purposes of the retirement earnings test.

                                   

Shift earnings to others                        

You may be able to reduce your net self-employment earnings if you shift earnings to others by forming a partnership with your spouse or employing minor children.

                                   

Caution:         The SSA may scrutinize questionable retirement arrangements. Under the law, you are entitled to work and combine your Social Security benefits and earnings in such a way as to get the most income you can. However, you should not understate your earnings or establish fictitious business arrangements.

                                               

Jared Daniel may be reached at www.WealthGuardianGrop.com or our Facebook page.

IMPORTANT DISCLOSURESBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.