Hosted by Creative Planning Director of Financial Education, Jonathan Clements and President, Peter Mallouk this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
Time Stamps:
[0:00] – When to claim Social Security
[10:27] – Coping with a financial emergency
[13:20] – Funding a Roth IRA
[14:00] – Biggest financial regrets
[16:50] – Peter Mallouk tip of the month
[17:35] – Jonathan Clements tip of the month
Transcript:
Jonathan Clements: Hi, this Jonathan Clements. I’m director of financial education here at Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, president of the firm and we are Down the Middle. It’s November 1st, Peter. We’re in the final couple of months of the year and we are here to talk about a couple of financial topics, and one of them is the topic of when to claim Social Security.
Obviously this is a big topic. Almost every American has to address this at some point in their lives. Everybody has this choice. You could take it early at age 62 or you can wait and the longer you wait the higher your monthly benefit is going to be. You can delay until as late as age 70, and if you delay from 62 through to age 70, your benefit’s going to be 76 or 70% larger in real terms, because of course, every year Social Security goes up with inflation. You talk to people, do you have some sort of basic advice that you give?
Peter Mallouk: In general, what we like to see people do is we like to see them wait to take Social Security and get the bigger benefit over the course of the rest of their lives, but you have to start to think about things that are non-financial like the health of the person getting Social Security. If somebody’s in poor health and not working it could often make sense, it usually makes sense to take it earlier because Social Security, the math on when you break even has to do with your life expectancy. If we know that the probability of the life expectancy is declining, that becomes a stronger case to take it earlier. The main factors we’re looking at are you still working and earning, and second, what is your health situation? Assuming that you’re retired and you’re in good health, we’re inclined to defer.
Jonathan: The situation becomes much more interesting when we’re talking about a couple, so if it’s a single individual obviously health is a big issue. As you indicated, if you are in poor health, take it early. If you’re in moderately good health, you probably want to delay, potentially until age 70 so you get that larger monthly benefit, and it’s not simply that you lock in that larger stream of inflation adjusted income, which is also treated preferentially from a tax point of view, but you also have what we can think of as longevity insurance. You know that no matter how long you live, you’re going to get this monthly benefit. But that’s for single individuals.
For couples, the calculus becomes much more interesting because you have two potential benefits. You have to decide when is each spouse going to claim their benefit, and as a rule of thumb, whoever had the higher lifetime earnings is going to want to delay their benefit for as long as possible, and preferably until age 70, even if that spouse is in poor health. The reason is this, because even if that spouse is in poor health, when he or she dies, that benefit is going to become the survivor benefit for the other spouse, so even if you’re about to drop dead, you want your surviving spouse to have that larger benefit because he or she’s going to have it for the rest of their lives.
Peter: That’s right.
Jonathan: It’s really only if both spouses are in poor health that you should be claiming early. The question that actually raises is one, okay, if the spouse with the higher lifetime earnings should delay as long as possible because that’s going to be the surviving benefit, what about the other spouse? When it comes to the other spouse, the spouse with the smaller benefit, it may sort of sound casual to say this, but it really doesn’t matter to a great degree. That smaller benefit, whether it’s taken earlier or later is not so crucial. It really is all about the major breadwinner’s benefit. If you’re more comfortable taking the benefit early, by all means go ahead. If you want to delay and have more inflation adjusted income for the rest of your life, by all means.
Peter: Yeah. I think it’s just another example of something that the government set up as a benefit. They set it up. The idea was you retire at 65 and your life expectancy was 65. Very few people were going to collect Social Security and now obviously it’s a big economic crisis in the United States. But I think more than that it’s just unnecessarily complicated, as the decision making depends a lot, to your point, are you single or are you married? Are you both high earners, both low earners, one’s a high earner and one’s a low earner? This is stuff that the average American shouldn’t even have to figure out.
We should have a system that helps people through retirement and that helps those that need it, and helps at certain ages that makes sense in today’s world, and that we have a tax base to cover it, and where we don’t have to make these super complicated decisions. We have to have specialists at Creative Planning to figure this stuff out. The same thing with Medicare and figuring out individual health insurance. I find it very frustrating. Somebody shouldn’t have to seek professional help or read 20 articles online to figure out something that every single American has as a benefit. But to your point, it’s very complicated and the key is understanding the assumptions you’re starting with, single, married, high income, low income, and is there a discrepancy between the spouses.
Jonathan: Whatever you do when it comes to the Social Security decision, don’t do what your neighbors say, and the reason I say this is if you talk to most experts, they will say in all likelihood you should delay your benefit, and yet, the statistics tell us that the most popular age for claiming Social Security is age 62. The prevailing belief out there is that you should claim Social Security as early as possible, and yet all the experts say that is typically not the right thing to do. Don’t just claim it at 62 because that’s what everybody you know does. Instead, investigate the issue and try to figure out what’s the right choice for you.
Peter: The age 62 is interesting because we see a lot of people do that and a lot of people think that Social Security will wind up being taxed or taxed more severely, depending on your situation or that it might go away completely, and so there’s this very large distrust of the government’s ability to sustain this or willingness to sustain it.
Higher income earners in particular seem to be a subset that believe that they’ll be excluded from Social Security in the future or it’ll be taxed punitively and so they’re taking it now. It’s interesting watching the political biases and beliefs bleed into the Social Security decision making. We’re not sure they’re wrong. There might be a severe tax on people later based on net worth or based on earnings that it could have made sense for them to take it earlier. It’s an interesting decision overall.
Jonathan: It is indeed an interesting decision. I do believe at some point that we’re going to see the age at which you claim Social Security rise. I mean it makes entire sense. When the system was first designed, people were not living much beyond 65. There wasn’t decades and decades in retirement and clearly there are now. Do we really want a system that encouraged people to spend the last 20 or 30 years of their lives sitting around doing nothing, which is what we currently have? That said, while I expect the age at which you can claim Social Security to rise at some point in the future, I strongly doubt that any politician wanting to get reelected is going to take away benefits from existing retirees. It just seems highly unlikely.
Peter: I agree. I don’t think they’re going to change it. When people talk about oh, they’re going to say you can’t do it unless you’re this age, I don’t see them retroactively, they’ll say starting in 2030 we’ll do this. But what I do see them potentially doing instantly is if you make this amount of money, we are going to tax your Social Security more, and that is the kind of thing I don’t think they’re going to say starting 10 years from now. I think they might say starting this year. That’s something that I think, especially when you look at the movement towards taxing the wealthy more, this is a very easy thing to get political support for is to say hey, people that make more than X, we’re going to take half their Social Security. I could see something like that gaining some steam.
Jonathan: Already if you have a relatively high income, 85% of your Social Security benefit is taxable, so there isn’t too much more to go before you hit 100%.
Peter: That’s true. Make it 100%. Make the tax on Social Security higher. Those things can easily happen.
Jonathan: One of the objections I hear to delaying Social Security is people say oh, but I could take my benefit early and then I could invest it in the stock market and I can earn a higher return in the stock market than I effectively get by delaying Social Security benefits, and depending on the rate of return you assume you can get a relatively young break even age on claiming Social Security early and then investing it in the stock market. I hear this so often and it’s really an apples to oranges comparison. I mean, when you look at Social Security what you’re talking about is a guaranteed income stream from the federal government.
When you’re talking about the stock market, you’re talking about something that’s lost its value by 50% twice in the last two decades. There is far more risk in the stock market than there is in Social Security. If you really did a comparison between taking Social Security early and putting it in the bond market, which would be a fair comparison, you’d find that the break-even is about 80 or 81. Most 65 year old’s are going to live to their mid-80s, so arguably, based on the numbers, assuming we don’t get the taxes that you’re talking about, assuming that Social Security isn’t restructured in some radical way by the politicians, based on the math and based on a fair investment comparison, it is still worth delaying.
Peter: Yeah, I agree. The way I look at Social Security is as if it’s a treasury bond. This is how I look at it, and if the implied rate of return of waiting a year in Social Security was what treasuries were trading at today, the big whooshing sound you would hear would be money flowing into the treasury market.
Jonathan: We’re talking about retirees. One of the other topics that we talked about discussing today was coping with financial emergencies. One of the rules of thumb out there is that everybody should have an emergency fund equal to six months of living expenses. What if you’re a retiree? Do you really need a financial emergency fund equal to six months of living expenses?
Peter: Well, I think it’s interesting because people say I need to have money in case of an emergency, but you really don’t need to have money in case of an emergency. You need access to money in the case of an emergency. Even somebody working, as long as they’ve got access, so let’s say that you’re invested in a stock and bond portfolio and God forbid something happens and you need $30,000. Well, as long as you could borrow against your account and meet those needs, if the margin rate’s at a couple percent, you can go meet your emergency needs and then go repay that when the emergency subsides.
But in the meantime you’re earning presumably more than you would earn leaving it in a savings account at the bank as your emergency reserve. If you’re retired, I think it even makes less sense to have an emergency reserve because the idea is if you’re banking $40,000 a year and if you lose your job, well, you need to have money for you to live on while you’re looking for the next job. But if you’re retired, we’re already living month to month off of the portfolio, and so the portfolio’s producing everything you need every month. If there’s something out of the ordinary, the financial plan, the portfolio should be accounting for certain things out of the ordinary.
Needing a new car is not out of the ordinary. You’re going to need a new car every whatever, 10 years or three years depending on the type of person you are, and so that should be budgeted within the plan and your portfolio should be designed to meet those needs. If we have a very, very big event, again, we just need to be able to borrow against a home equity line of credit or an investment account or something like that. But in the meantime you’re able to leave your portfolio engaged where you’ll presumably earn more than having money sitting around in a savings account.
Jonathan: Yeah, so I think there are two important points here. One is that an emergency fund is largely an unemployment fund, and if you’re no longer dependent on a job for your income, which is the case for retirees, you need far less emergency money and as you suggest, maybe a total of zero because you’ve already got plenty of cash sitting around to cover your spending needs in the years ahead.
The second thing is it’s not so much about having cash, but having access to cash. If you can borrow against your portfolio, if you have a home equity line of credit, that can provide you with the cash. I mean nobody wants to be borrowing against their house or their portfolio, but if you have those lines set up you can draw them if you find yourself out of work and then hopefully get a new job and then repay them as quickly as possible.
Peter: Yes, exactly.
Jonathan: One of the things that I talk to young people about and we’ve discussed in earlier podcasts is funding a Roth IRA when you’re younger. If you’re entering the workforce and you start funding a Roth IRA, you’re not simply starting out on a lifetime investing, but also in a sense you’re creating an emergency fund, because remember, every dollar that you put in a Roth IRA, you can withdraw your original contributions tax free at any time with no tax consequences. If you put $6000 in a Roth IRA today, you can pull it out tomorrow to cover your financial emergency and you owe nothing to the government. If you’re early in your career, fund that Roth IRA and you’ll be building up your emergency fund at the same time.
Peter: Nothing beats the Roth IRA. No one should miss an opportunity to contribute to one.
Jonathan: Until those sneaky politicians add the tax again.
Peter: That’s right. Exactly, until then.
Jonathan: One of the things that we were also going to talk briefly about was our biggest financial regret, so Peter, what is your biggest financial regret?
Peter: My biggest financial regret, and I didn’t learn enough the first time, I made it a few times, was loaning money to a friend. In college I had somebody that couldn’t make a couple month’s rent and I loaned them some money and then it created this they couldn’t pay me back and then I had to ask for it back. It just created this tension, and what I realized is not only is it a very risky deal to loan money to a friend, but it monetizes the relationship and so you create a relationship that now has a money component to it.
You’re suddenly a bank. They’re suddenly the borrower, and it doesn’t make the relationship better ever. The question is can you maintain it as it is, or is it going to get worse, and that was my first lesson in that. It’s something that I see, unfortunately, clients get burned by over and over and over again. I had a client recently that a cousin wanted to start a development and she loaned him money, and all this is a sure thing and then the development folded and she didn’t get the money back. Now every holiday is more awkward.
Jonathan: I would say my biggest financial regret because there’s still some minor financial regrets, you know, investments I wish I hadn’t poured and so on when I was young and foolish as opposed to being old and foolish. But I think my biggest regret looking back over my three decades as an investor is simply paying too much attention, looking at the financial markets too often, looking at my financial accounts too often. In many ways this is sort of information without insight, just watching the market go up and down. There is nothing to be learned from that, watching the value of your account go up and down.
There is nothing to be learned from that. It’s more likely to cause you to make foolish financial transactions that actually lead you to know something more about your financial future. If I had any regret it’s simply looking at my financial status too often, and the problem is we live in a world where it’s so easy to do that. You go back 30 years and you didn’t know how your stocks had performed until you looked in the newspaper the next morning. You didn’t know how your portfolio was doing until you got your monthly or quarterly account statement. Now we can find out every single second of the trading day and it’s not helpful.
Peter: That’s right. It’s not. In fact, it’s negative and I think you could take that from money and apply it to a lot of things, like I used to watch a lot more news. I said what’s going to happen if I don’t watch news for a month? You know what happened? Nothing. I mean, my life just got a little bit nicer and easier. I had more time. My day was a little more enjoyable, and the same thing with just not looking at the account every day. You really don’t gain anything from it. In fact, the implications are mainly negative.
Jonathan: Yeah. We’re at the time of the podcast, your tip of the month.
Peter: Sticking with our Social Security theme, if you’re over 62, even if you’re not receiving benefits, you should set up an online Social Security account and that way you can just monitor for fraud. To hear a personal story, my dad found out that his Social Security check, this happened a while ago, was just going to somebody else. Someone had somehow got enough information and made the claim and was collecting his Social Security check, and this is something that we’ve seen with clients over and over again. It’s a very common scam. If you want to kind of stay in touch with your Social Security benefit, go on ahead and set up an online account if you’re 62 even if you’ve listened to the first part of our podcast and decided to defer making the claim.
Jonathan: My tip for the month ahead is to encourage people to write stuff down, and particularly write down details on some area of your life that you would like to improve. Let’s say that you want to lose weight.
Peter: Well, this doesn’t help with denial, Jonathan. Maybe that’s your whole point.
Jonathan: That is the whole point. Let’s say you want to lose weight. Make it a point of writing down everything that you eat and simply doing that will make you more conscious of what you’re putting in your mouth and you will start to eat less. Ditto for spending. If you’re trying to save more money, write down every time you make a purchase, and if you do that you become more thoughtful about what you buy. I’d also like to extend this to exercising, but I’m not sure it quite works because you can’t really, but I would say write down every day what you did or didn’t do physically to work out. If you make it a point of filling out that diary and writing down what you did or didn’t do, you’ll want to have something to put in that slot for that particular day and maybe you will go to the gym or you will go out and take a run.
Peter: Yeah, I will say there’s no doubt that having to keep track of things increases accountability. There’s a few folks in my family that use the Apple Watch or things like it that tracks their steps and all that, and they will go out of their way to make sure they get their steps because otherwise they’ve got to look at that, that they didn’t hit it that day.
Jonathan: Yeah, I see this with my wife. She counts steps, and if it gets to the end of the day and she hasn’t quite hit her 10,000, we live in an apartment building, she will just walk down the stairs and walk back up just to get that 10,000.
Peter: That’s great. Yeah, I’ve seen my dad walking around the swimming pool a hundred times in a row at times. It’s pretty funny, in the backyard just to make sure he gets his steps up.
Jonathan: All right, well, that’s the end of another podcast. Peter, it was a fun conversation. We are here in Overland Park, Kansas, and we are Down the Middle.
Disclosure: This commentary is provided for general information purposes only and to not be construed as investment, tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed to be reliable but is not guaranteed.
