The Downsides of Saving for College Expenses

Just as a parent will wake up at 3:00 am to feed a hungry new born, a parent will save for the child's college expenses. Many commentators recommend that you first fund your retirement, and use any remaining money for college savings. The idea is that you don't want to be a burden on your kid(s) when you're old. Given the amount of money it takes to retire comfortably, most people would have little left for college expenses if they actually took care of retirement first. But the parental instinct to provide for the child--be it with food or with an education--extends beyond financial rationality. People will save for the educational expenses of their children, even at the cost of adequately funding their own retirements.

That being the case, they should be aware of some of the pitfalls and downsides of saving for college expenses. The 529 Plan and the Coverdell account are heavily promoted today, especially the 529 Plan. Both a 529 account and a Coverdell account offer tax advantages--the money you put into them isn't tax deductible, but the earnings are not taxed if they are used to pay college expenses. Coverdell accounts can also be used to pay primary school expenses. Some states offer deductions from state income taxes to their residents who open an account in a 529 Plan offered by that state.

However, there are the downsides, which you not hear much about. Each 529 Plan has only a limited number of investment options. The plan itself, and the investment options, may impose high costs and fees on your account (as much as 3% per year in some cases). That's a hefty burden. Even with the tax shelter offered by the 529 Plan, fees at that level seriously reduce your long term returns. If you compare an expensive 529 Plan against an inexpensive taxable account (one where you pay taxes on realized investment gains each year), the inexpensive taxable account can produce greater wealth.

Another problem with 529 Plans is that if the money in your 529 account isn't used for college expenses, you can retrieve it only after paying state and federal income taxes, and a 10% penalty on the earnings. So you have an exit strategy problem if Junior doesn't go to college; or does go, but doesn't graduate. Something like 1/3 to 1/2 of all college freshman do not graduate. If you save for college expenses in an inexpensive taxable account, you have no exit strategy problem and may even come out ahead.

A 529 Plan is a good idea if you can find one with low costs. You can search for low cost 529 Plans at www.savingforcollege.com. Among the plans that appear to have low costs are the Utah Educational Savings Plan Trust, the Virginia Education Savings Trust, the South Carolina Future Scholar 529 College Savings Plan (Direct-sold), and the New York 529 College Savings Program--Direct Plan. Note that you don't need to be a resident of a state to participate in its 529 plans. Also, you have to contact each of these states directly to open an account--these plans are not sold by brokers (which probably accounts for much of their low costs, since no one gets a commission for selling you one).

Finding Coverdell accounts with low costs tends to be easier than it is for 529 Plans, since you can open a Coverdell with a wide array of financial institutions. One downside of the Coverdell account is that you can only contribute $2,000 a year (the 529 Plan's limit is $12,000--or $24,000 for a married couple--a year). Also, the Coverdell can only be used by people subject to certain income limits. The Coverdell has a severe exit strategy problem: if the account assets aren't used for educational purposes by the time the child who is the beneficiary of the account is 30, the child gets the remaining assets (subject to payment of state and federal income taxes and a 10% penalty on the earnings). You don't get any of the money back for your retirement or any other purpose.

Persons having incomes below $78,100 if they're single, or $124,700 if they're married filing jointly, may be able to avoid paying some or all of the taxes due on the interest income of U.S. Savings Bonds that is used for college expenses. So U.S. Savings Bonds actually provide a tax shelter for college savings for persons meeting the income requirements. Since Savings Bonds can also be used to fund your retirement, they don't have an exit strategy problem. They're also simpler than 529 Plans and Coverdell accounts.

The tax sheltered plans--529 and Coverdell--also require extra work at tax time, especially when your taking money out to pay for educational expenses. If you're concerned about the downsides of 529 Plans and Coverdells, just save for college expenses in low cost taxable investments like well-diversified mutual funds or U.S. Savings Bonds.

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How to Maximize Your Investment Gains

Profiting from investment consists of two things: (a) making money; and (b) keeping it. There is risk in almost every investment--even federally insured bank deposits are subject to loss of value from inflation--and risks can cause losses.

Risk and reward walk hand-in-hand down Wall Street. The higher the potential rewards of an investment, the greater the risks it involves. If you invest in something that offers large potential gains, understand that it's likely to have high risks of loss as well.

From time to time, you may hear of investments that are sure bets. When someone offers you a chance at one of these sure bets, put your hand on your wallet and go for a walk around the block from which you don't return. There are no sure bets in the financial markets.

Maximizing your investment gains involves a balancing of risks and rewards. Look for investments with reasonable returns and moderate risks, and you have a good chance of making money and keeping it in the long run.

So, if you are an ordinary investor, what are good investments? We mean the ones where you have a reasonable chance of receiving gains and then keeping them. Here are some ideas:

1. Stocks and stock mutual funds: stocks give you ownership of a small piece of a company. Stock mutual funds own a large number of different stocks, and give you a tiny bit of ownership in all the stocks that the mutual fund owns. Stocks are generally a good long term investment. Of course, we all know that the stock market fluctuates. But if you ride through the ups and downs, you'll likely do well over the years. Stock mutual funds smooth out some of the ups and downs by giving you a diversified pool of investments. As a mutual fund investor, you put your eggs in many different baskets, and therefore have a smaller chance of taking major losses from any particular stock.

2. Bonds and bond mutual funds: bonds are an investment where you invest an amount of money (the "principal") in the bond. The company or government that issued the bond pays you interest from time to time, and eventually repays the principal. In this sense, bonds are like bank certificates of deposit (except they aren't federally insured, although U.S. Treasury bills, notes and bonds are safe). A bond doesn't offer great potential for gains. However, it tends to have low risks, especially U.S. government bills, notes and bonds. A bond mutual fund holds a number of different bonds and helps to diversify your bond investments. You would invest in bonds and bond mutual funds to provide stability to the value of your financial portfolio. Every portfolio should have some stable assets, especially as you get older.

3. Lifecycle or target date mutual funds: these mutual funds hold both stocks and bonds. They are a blended mix of financial assets and are designed to give you the potential of stocks for good long term growth while somewhat stabilizing the value of your portfolio by investing some assets in bonds. The company managing these funds does the investment selections for you, so all you have to do is pay in your money and let them do the rest of the work.

4. Real estate: we now understand that real estate is not a wonder asset that will make everyone rich through no effort whatsoever on their part. Real estate historically has increased in value more slowly than stocks (about 1% after inflation versus approximately 3% after inflation for stocks). Nevertheless, everyone needs a roof over their heads and buying real estate is a good way to pay for that roof while adding to your investment portfolio. Owning a home provides some diversification away from the financial markets, and the home could serve as an asset of last resort in retirement, especially if you own it free and clear of debts.

5. Education: last, but certainly not least, is education. The gap in earnings between those who have a four-year college degree and those who don't has been growing over the years. The U.S. economy has shifted away from traditional manufacturing to knowledge and informational based activities, and it rewards those who know how to utilize knowledge and information. A college education doesn't provide everything you need for a job or a career. But it teaches you how to learn. You have to absorb information faster and on a more sophisticated level in college, and therefore you learn how to learn. That skill is highly rewarded in an economy based on knowledge and information. Education is one of the best investments you can make. Don't worry a great deal about which college you attend. Statistically speaking, there is little evidence that going to an expensive Ivy League school will make you significantly wealthier than attending a good state university. Just make sure you graduate.

Strange News: Apes with expensive tastes--http://abcnews.go.com/Technology/CSM/story?id=3158484&page=1.

How the Right Mortgage Loan Helps You Build Wealth

One of the basic principles of personal finance is to keep things simple and understandable. Simplicity allows you to understand where your risks are, and to figure out how to deal with them effectively. Complicating your personal finances forces you to drive on foggy roads, and you may not see every obstacle in time to avoid it.

The most recent illustration of this point is in the real estate markets. Many homeowners are struggling to meet payments on interest only mortgages, adjustable rate mortgages and option ARMs. Foreclosure rates are increasing. And, with real estate values sluggish or dropping in many major markets, your ability to refinance out of a bad loan is limited or nonexistent.

Interest only mortgages and option ARMs seem like great loans at first. You need to make only modest monthly payments, and it's easy to qualify for a nicer house than you thought you could buy. However, it's important to understand that these loans allow you to delay repayment--but not indefinitely. An interest only loan lets you pay only the interest on the loan for a short time, such as a year or two or three. Then you will have to start paying the principal of the loan. Your monthly payment will jump, and by quite a bit.

The option ARM allows you not only to delay repaying the principal of the loan at first, but also to delay payment of some of the interest. But the unpaid interest is added to the principal of the loan, effectively increasing the amount of the debt. The monthly payments in options ARMs tend to increase sooner rather than later (sometimes within months). With the addition of unpaid interest to the principal, the increase in monthly payments could be seriously painful.

Adjustable rate loans begin with an interest rate that will be effective for a year, or a few years. Then the loan rate will change as interest rates in the financial markets change. But the change is likely only to go upwards. Adjustable rate loans tend not to decrease the rate (you usually have to refinance to get a lower rate). You could see a big jump in payments if interest rates rise significantly.

The common thread among all these loans is that they are complicated and often unpredictable. You can't effectively budget or plan for your long term financial well-being if you don't know what your mortgage payment will be in a year or two. Things only get worse if you can't afford the increased payment. You may be unable to buy the new car you need, and will have to hope the brakes and tires on your old car last a while longer. Money you wanted to save for your golden years or your child's college expenses may be devoted to the greater profitability of your mortgage lender.

So, what to do? Use a traditional fixed rate mortgage. This loan locks in your housing costs. You know how much you'll have to pay each month of the loan. There will be no surprises. Once the loan payment is fixed, you can budget around it and allocate money for savings. Look back at the World War II generation. Before the war, mortgages tended to be for a short duration (like 5 years) and require substantial downpayments (like 50%). When the GIs returned from the war, the 30-year fixed rate mortgage came into common usage. The housing market boomed and home ownership rates rose. With fixed housing costs, the members of this generation could and did build wealth perhaps like no generation before them. They were often able to fully pay for their homes and save money beyond that.

Yes, initially the cost of a fixed rate mortgage is higher, with a larger monthly payment. But no one can predict the direction of interest rates. A loan with an adjustable rate, or which you have to refinance in a few years because you can't afford the payment increases, may cost you more over the long term than a fixed rate mortgage. Further, incomes tend to rise over time, so your income will probably increase while a fixed rate mortgage's monthly payment does not. The extra money can enhance your lifestyle and increase your retirement portfolio. People earning $5,000 a year in 1955 might have had a mortgage payment of about $150 a month (seriously, many mortgage payments were this low). By 1975, they might have been earning $15,000 or $20,000 a year; but their mortgage payment was still $150 a month. That's a good situation to be in.

Fixed rate mortgages may not initially be as easy to get or pay as other, more complex loans. But most things in life worth doing or having don't come easily. The fixed rate loan ultimately makes your life simpler and easier. That will be conducive to your financial well-being. Even if you have to buy less house, you'll have more peace of mind.

Personal Grooming News: Men wearing makeup--http://www.wtop.com/?nid=456&sid=1137695.

How to Teach a Child to Manage Money and Save

The easiest way to build wealth is to start early and save often. A child who learns basic money management skills will spend sensibly and save as soon as he or she enters the adult work force. A person in his or her 20's that has the habit of saving and investing will benefit from a lifetime of good money habits. How do you teach a child to manage money?

1. Give the child an allowance and a piggy bank. After the child has learned to count (at least up to 100), and is familiar with cash (coins and bills), give the child two things simultaneously.

First is an allowance appropriate to the child's age. At age 7, 8 or thereabouts, something like $2 a week might be a good place to start. That's enough to buy a few little things, but not enough for the little one to get into trouble. This allows the child to become familiar with money.

Second is a piggy bank. It is important for the child to understand from the outset that money can be saved for future use and that saving some or all of the allowance will build up money for more expensive things. The child will learn very quickly to think about money as a resource that can be conserved and made to grow over time.

It's important to give the child the allowance and the piggy bank at the same time. Receiving money and saving it should be associated in his or her mind from an early age.

2. Hold the Line on the Allowance. If the child spends all of his or her allowance and then wants a supplement before next week's allowance, don't give in. The child should learn that money is a limited resource and must be spent wisely. Increasing the allowance as the child grows older makes sense. But whatever the amount, don't supplement it. It's important for the young one to learn how to control the impulse to spend.

3. Encourage Math Skills. All aspects of handling money--spending, saving and investing--require an understanding of math. Basic elementary school arithmetic--addition, subtraction, multiplication and division--is sufficient to handle most daily money problems. A middle school level understanding of decimals, exponents and how to read charts and graphs is helpful to understanding investments. Financial markets enthusiasts and Wall Street professionals often use more advanced math, such as statistics and differential equations. The more easily a child grasps mathematical concepts, the better prepared he or she will be to deal with money and investments. It helps if the child can do simple arithmetic in his or her head, without the need for a calculator. Make a game or contest of memorizing multiplication tables; your child will reap a lifetime of rewards from this bit of knowledge.

4. Have the Child Open a Savings Account During High School. Many parents give their kids credit cards (usually with a very small limit) at some point during high school. This isn't a bad idea, since it helps the child to learn about the modern financial system. But don't just give the young one the means to spend. Teach the child how to use the financial system to save and build wealth. Many banks offer special interest bearing accounts for children that allow very small balances without any fees or charges. These accounts can sometimes be opened for as little as $25 or $50. Make sure your child has one, preferably during high school. Watching the balance grow and accrue interest will teach your child about the process of building wealth. This is something a young person should understand before going off into adulthood.

5. Set a Good Example. Kids take after their parents. We all know that. Set a good example for your kids and be sensible about money. You'll not only be rewarded with financially skillful children, but may boost your own retirement portfolio in the process.

For more ideas about kids and money, check out Kids & Money at http://www.money-hacks.com/2008/05/kids-money-may-9-2008-found-edition.html.

For more ideas about money and personal development, check out the Personal Development Carnival: http://personaldevelopmentcarnival.com/.

More on Kids: Children conceived in the summer tend to do less well on a standardized test. See http://www.nbc4.com/family/13270087/detail.html. Hmmmmm. Well, summer's not a bad time to take cold showers anyway. But health care workers beware. There could be seasonal layoffs in the maternity wards from March through May.

Strange News: For all you fashion plates, read the latest about antibacterial ties: www.nbc4.com/technology/13271695/detail.html. Is someone getting a little too obsessive?

How to Become a Millionaire

So you want to become a millionaire? Here are a few ways, none of which involve calling an 800 number advertised on late night TV.

1. Save $15,000 a year in a 401(k) account (or an equivalent account, like the federal government's Thrift Savings Plan) for 26 years, and you will probably get there. We assume that your investments earn 7% a year. Since you're using a retirement account, your investment earnings will automatically compound. You should invest the account assets in a diversified mix of mostly stocks and some bonds (roughly 60% stocks and 40% bonds). Investing in a lifecycle or target date mutual fund would be a convenient way to get a diversified mix of assets. We also assume that you don't make any withdrawals or take any loans from the 401(k) account. (That way, your investment earnings will compound without interruption.)

If you want the inflation adjusted equivalent of $1 million, increase the amount you save each year by the rate of inflation. You'll probably be able to do this since incomes for most people tend to keep approximate pace with inflation over the long run. Even if your income doesn't always increase as much as the inflation rate, make sure your savings keep pace. Maybe you'll lose a little lifestyle, but you'll get better quality of sleep.

2. Save $10,000 a year in a 401(k) or equivalent account for 31 years. This is based on the same assumptions. Increase your savings annually by the inflation rate to maintain your buying power.

3. Save $7,500 a year in a 401(k) or equivalent account for 35 years. This is based on the same assumptions. Increase your savings annually by the inflation rate to maintain your buying power.

4. Save $5,000 a year in a 401(k) or equivalent account for 40 years. This is based on the same assumptions. Increase your savings annually by the inflation rate to maintain your buying power.

None of these methods will make you a millionaire quickly. But they don't require any special skills, an advanced degree, a bundle of stock options, or a winning lottery ticket. Anyone who is patient and saves steadily can get there. Most people who are well off accumulated their wealth bit by bit. It doesn't matter if you don't make a huge income. The tortoise wins this race, not the hare.

Tacky tacky: See the latest in legal advertising: http://www.nbc4.com/slideshow/news/13278632/detail.html. Is this a new low?

A Financial Checklist for Job Loss

Losing a job is one of the stressful things that can happen. You know you are in financial peril, but may find it hard to think straight and remember things that might be helpful. Here's our list of suggestions for softening the blow.

(a) negotiate for as many weeks or months of termination pay as you can get;

(b) ask for payment of any bonuses, awards or commissions you’ve earned or accrued, or which you can reasonably expect based on your job performance to date (if the award was in non-monetary form, like a trip to Hawaii, ask for the monetary value of the trip);

(c) request payment for accrued vacation and sick days, and any other time off you've earned or been awarded;

(d) ask for continuation of health insurance benefits (remember that you have COBRA rights to retain your employer’s health insurance for 18 months even if your employer doesn’t offer anything else; even though you’d have to pay the entire cost of COBRA coverage yourself, it's still worthwhile);

(e) ask for continuation of other insurance benefits, such as dental coverage or life insurance;

(f) obtain a written statement of the balance in your 401(k) account and any other retirement accounts you might have with the employer, such as an employee stock option plan--the assets in these accounts are yours (except possibly for matching funds from your employer if you haven’t had the job all that long) and you don’t have to negotiate for them; but you should make sure you know how much is there;

(g) claim any stock options, restricted stock and similar incentive compensation benefits that you have earned or are entitled to;

(h) ask about retaining any employer provided equipment, such as a laptop computer or a car, if this equipment is important to you;

(i) ask for the employer’s agreement not to contest your claim for unemployment compensation (if it looks like you’d qualify for unemployment comp);

(j) ask for your employer’s agreement to give you a good reference (or at least a neutral reference such as only a confirmation of dates of employment and positions held); and

(k) ask your employer for assistance from an outplacement or headhunter firm (that the employer pays for).

Your ability to obtain these benefits will depend on the circumstances of the situation, but they are something for you to think about. Certainly, if you don't ask for them, you probably won't get them. If you are represented by a union, consult with a union representative about your rights and options.

Some people try to negotiate for a temporary continuation of employment while they search for a new job, on the theory that it’s easier to find work if you are employed. Others may aim for the use of an office and telephone line at the old employer’s office while they search for a job, to maintain the appearance of being employed. You may want to consider these possibilities. But don’t lie to a prospective employer about your actual employment situation.

Carefully read anything your employer asks you to sign in connection with your termination. Almost always, an employer offering termination benefits will ask you to waive your rights to sue for discrimination, wrongful discharge and other potential legal claims or rights. If you’re seriously considering a lawsuit, don’t sign anything even if that means losing some of the termination benefits. You should be able to use COBRA rights to maintain your health insurance (unless you’ve engaged in “gross misconduct”). If you sign a document that waives your COBRA rights, you can still revoke that waiver for a limited period of time (which should be at least 60 days after your regular employer sponsored health insurance plan’s coverage ends). The assets in your 401(k) or other retirement accounts are yours in any event, so you don’t have to waive any rights to get them.

You may be able to get unemployment compensation. Do so if possible because unemployment comp will help to extend your financial resources.

Of course, start looking for another job as soon as you can. You can't build wealth for retirement unless you keep working. Losing a job can be one of the most emotionally difficult events of your life. But remember that it happens to large numbers of people every year; you are hardly alone. Don't lose faith in yourself. You'll have sunny days as well as cloudy ones. Hang in there and wait for the clouds to blow away.

Strange News: A Brazilian court has ordered a brewery to pay one of its beer tasters compensation for facilitating his alcoholism. See www.wtop.com/?nid=456&sid=1133982. Hmmmmm. They paid him to drink so now they have to pay him for drinking. What's his incentive to stop drinking?

In Your 20's: Money Matters When Time is Your Friend

When you’ve finished your education and are starting out in the work force, you have perhaps the best opportunity of your life to put your finances on a solid footing. Time is very much on your side. If you control your spending and start a savings program when you’re young enough to benefit from 40 years of compounding investment earnings, you’ll find retirement a lot easier to finance. If you’re like many people, you may not think much about next year, let alone your 60’s. Remember, however, that you’ll probably reach your 60’s (and the alternative is worse if you don’t). You’ll be happier then if you do some advance planning now. Take a few basic steps and you’ll be off to a good start.

1. Live within your means. Don’t try to emulate friends who can lease BMWs because they’ve moved back in with their parents after college. It’s easy to maintain a fancy lifestyle if someone is subsidizing you. But if you’re on your own, live carefully. You’ll become self-reliant, and in the end that will be worth much more than parental subsidies.

2. Build up an emergency cash fund of 6 to 12 months expenses. The emergency cash fund serves as a personal insurance policy against all the bad things that might happen to you which aren’t otherwise insured. For example, if you have a serious car accident, or a rock climbing accident, and can’t work for three months, where will you get money to live on? If you have health insurance (and you should get it, even if you have to pay for it personally), your medical costs will be covered. But you’ll still need money for deductibles and co-pays, food, rent, utilities, car payments, etc. An emergency cash fund may be $20,000, $30,000 or more. That looks like an awful lot of money to have sitting around. But all insurance looks like a waste until you need it. Then, you’ll be very glad you have it. Put the emergency cash fund in an account that is separate from your regular checking account, so that it’s not easy to spend. Good places include a bank or credit union money market account (preferably one that pays a decent interest rate) or a money market fund. Money market funds are actually pretty safe, especially ones that invest exclusively in U.S. Treasury securities, and tend to pay better interest rates than most bank accounts. Some online banks pay relatively high interest rates.

3. Start saving in a retirement account. Open a 401(k) account or other retirement account if your employer offers one. Otherwise, open an IRA. A Roth IRA is probably best if you’re young. These accounts are the best legal tax shelters available to most Americans, so be sure to have one.

4. Don’t run up your credit card debt and pay off any balance you’ve been carrying over from month to month. Credit card debt is expensive because the interest rates are high. Try to stick with just one or two credit cards. Bouncing from one card to another to another isn’t good for your credit rating. Keeping one or two cards for a longer period of time is better. If you consolidate your debt, use the cash flow you free up to pay down debt. Don’t use it for more lifestyle enhancement. The problem with debt is that it is supposed to be repaid, and the interest charges will eventually crimp your lifestyle. Why enrich banks? Pay off your debts and enrich yourself.

Strange News: Apparently the reason why Paris Hilton is going to jail is because she took legal advice from her publicist: http://www.reuters.com/article/wtMostRead/idUSN0339694420070506. Okay. Maybe in La La Land this makes sense. Have you ever heard the joke about asking two publicists the same question and getting three answers . . .

More money hints for those under 30 can be found at this blog carnival: http://howtomakeamilliondollars.blogspot.com/2007/05/festival-of-under-30-finances-june-1.html.

Mysteries of Social Security Retirement Benefits: Part Trois--Who

In our two preceding blogs, we discussed how the Social Security Administration determines your retirement benefits, and the advantages and disadvantages of starting to collect benefits at various ages. Today, we discuss who receives benefits. This is where Social Security may be a bit more generous than you might have thought.

You, naturally, receive benefits based on your employment history. Your spouse can also receive benefits based on your employment history, up to as much as half of your benefits. Like you, however, your spouse is receives reduced benefits if he or she starts collecting them before his or her full Social Security retirement age. (We discussed full retirement age in yesterday's blog.) Conversely, you might be able to receive Social Security based on your spouse's employment history.

If you have an employment history that entitles you to benefits and are married, you will receive the benefits you have earned from your own employment history. In addition, if your spousal benefit would be larger than your personal benefit, you would receive an amount equal to the difference between your spousal benefit and your personal benefit. In other words, the amount you get is the greater of your personal benefit or your spousal benefit.

Divorced persons may be able to collect Social Security retirement benefits based on the employment history of their former spouses under some circumstances. They must have: (a) been married for at least 10 years; (b) reached the age of at least 62; (c) be currently unmarried; and (d) not be entitled to a larger benefit based on their own employment history. So not all is lost from the relationship. You can receive up to half of the amount of your ex's full retirement benefits if you wait until your full retirement age. Your spousal benefits will be reduced if you start earlier.

One little known fact about Social Security is that if you are entitled to retirement benefits and have dependent children or grandchildren, the kids under the age of 18 or who are disabled can start collecting benefits when you do. So late in life parents, and grandparents who are raising their grandkids, can get some help. This benefit is subject to limitations on much your family can collect in total (about 150% to 180% of the benefits you receive). If you are eligible for Social Security retirement benefits and are in need of cash to raise the young ones, here's some relief. If you don't need the money, save it up and use it as a college fund for the kids.

Social Security also provides life insurance of a sort, in the form of survivors benefits. Survivors can receive benefits, depending on the deceased person's employment history. A widow or widower can receive benefits as early as age 60, although they will be sharply reduced from what the widow or widower would receive at his or her full retirement age. A divorced survivor who was married to the deceased for at least 10 years and remains unmarried may also be entitled to survivors benefits starting as early as 60. A widow or widower (or divorced survivor) of any age who is supporting dependent children under the age of 16 or disabled children (who themselves are entitled to a child's benefit) may also be able to get survivors benefits. Unmarried children under the age of 18 can receive benefits (and can get them up to age 19 if they are still attending primary school or high school). Even your dependent parents, if you are providing at least half their support, can collect benefits if they are at least 62. Survivors benefits are complex, and we have only touched the surface. For more detail about survivors benefits, go to www.socialsecurity.gov/pubs/10084.html.

There's lots more to Social Security. People receiving pensions from governments or nonprofit institutions may be subject to nasty reductions and offsets if they didn't pay Social Security taxes in those government or nonprofit jobs, even if they otherwise qualify for Social Security benefits from other jobs. Your painkiller budget will skyrocket if you ever have to deal with Social Security disability questions. But it's important to be familiar with Social Security. Close to 50 million Americans receive benefits of one type or another. Almost 34 million receive retirement benefits. About 6.5 million receive survivors benefits. And about 8.6 million receive disability benefits. That means 1 out of every 6 Americans receives something from Social Security. It's by far the most important social welfare program in the country, and one that will benefit almost everyone eventually.

Strange News: Okay, enough already about Social Security. Talk about an incredible headache. How about eco-friendly beer (as if you needed another excuse to drink the stuff)? Read this: http://www.nbc4.com/technology/13251664/detail.html.

Mysteries of Social Security Retirement Benefits: Part Deux--When

In our preceding blog, we gave you a thumbnail sketch of how Social Security determines your retirement benefits. Now, we discuss when you might want to start collecting benefits.

The earliest you can start collecting retirement benefits is age 62. The amount will be less than what you'd get if you waited until your "full" Social Security retirement age. Your "full" Social Security retirement age depends on when you were born. If you were born any time from 1943 to 1954, your full retirement age is 66 (it's lower if you were born before 1943, but in that case you're probably already collecting benefits or about to start collecting them). If you were born in: (a) 1955, full retirement age is 66 and 2 months; (b) 1956, full retirement age is 66 and 4 months; (c) 1957, full retirement age is 66 and 6 months; (d) 1958, full retirement age is 66 and 8 months; (e) 1959, full retirement age is 66 and 10 months; and (f) 1960 or later, full retirement age is 67.

The next question is how much less do you get if you start collecting benefits before your full retirement age. While the Social Security website (www.ssa.gov) isn't precise, it does give a couple of examples. If your full retirement age is 66, the reduction in benefits: (a) at age 62 is about 25%; (b) at age 63 is about 20%; (c) at age 64 is about 13.3%; and (d) at age 65 is about 6.7%.

If your full retirement age is 67, the reduction in benefits: (a) at age 62 is about 30%; (b) at age 63 is about 25%; (c) at age 64 is about 20%; (d) at age 65 is about 13.3%; and (e) at age 66 is about 6.7%. If your full retirement age is between 66 and 67, the reductions apparently are somewhere between the amounts for ages 66 and 67.

It's important to understand that these reductions are permanent. If you start collecting benefits at age 62, they will always be about 25-30% less than the benefits you would have gotten if you had waited until your full retirement age. The fact that you are getting benefits sooner, and may be able to stop working at an earlier age, may make it worth your while to forego the higher benefits available at a later age. Just be sure you understand the cost.

If you delay taking benefits after your full retirement age, your benefits will increase even more. That's especially true if you continue to work. The amount of the increase will depend on whether or not you work, how long you work and how much you earn. For people born in 1943 or later, a boost of 8% per year is provided for each year of delay (and your benefits may be further increased if you keep working). So you might be able to leverage your benefits upwards as much as 24% or more over your full retirement age benefits if you wait until age 70. But start collecting them when you hit the big 7-0, because they don't increase with further delay.

So, when should you start collecting retirement benefits? That depends on your personal situation. If your health is good and you think you have a long life expectancy, delay benefits as much as possible. That way, you'll have better protection for the last years of your life, when your savings may run low. The benefits you get by waiting until 70 can be 50% or more than the amount you'd get starting at age 62, so we're talking about some serious pocket change. As we discuss in Uncle Leo's Den, boosting your Social Security benefits is a valuable way to pump up your retirement resources.

But be careful if you've stopped working. Without a job, how would you live for the years before you started to take Social Security? If you have a pension, you may be able to get by with that. But if you'd have to burn off a lot of your savings in order to delay benefits, you may be better off starting benefits earlier and conserving your savings. Retired people can't replace spent savings, so if your savings are modest, keep them warm and dry for big expenses like medical care.

On the other hand, if your health is poor, consider taking benefits at age 62, especially if you are unable to work. That way, you'd get something back for all the Social Security taxes you paid.

The answer becomes more complicated if you are married. Your spouse is entitled to Social Security benefits based on your record, and can collect up to half the amount of your benefits (but only when you start to collect). If the two of you are short of cash, and the total amount of your combined benefits would provide badly needed cash flow, it could make sense to start collecting earlier. However, be cautious about jumping the gun. The spousal benefit shrinks if your spouse begins collecting it before his or her full retirement age, similar to the shrinkage in your benefits if you begin collecting them before your full retirement age. Make sure the sacrifice is worthwhile.

While there may be many nuances to the question of when you begin collecting Social Security retirement benefits, our discussion should give you a general idea of what it's all about. Granted, thinking about this stuff can become mind-numbing after a while. But you could receive hundreds of thousands of dollars from Social Security during your retirement, and that's worth a few headaches.

Our next blog will continue to explore the mysteries of Social Security retirement benefits.

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Mysteries of Social Security Retirement Benefits: Part 1--How

(As Updated May 8, 2011)

Have you ever wondered how the Social Security Administration determines your retirement benefits? If your answer is no, you pass the sanity test, because no sane person would try figure it out. But if you want to give it a whirl, here's their website: www.ssa.gov. Good luck.

On the other hand, it's worth having a basic understanding of how Social Security works so that you'll know how to maximize your benefits. Our thumb nail sketch is below.

First, to become entitled to any retirement benefits at all, you have to earn 40 Social Security credits. You get a credit by having a minimum amount of earned income (or, net earned income if you're self-employed) per year. In 2007, the amount needed for one credit is $1,000. This amount will be adjusted upward in future years in line with general increases in wages. You can earn up to 4 credits per year. So, if you have at least $4,000 in earned income (or net earned income for the self-employed) in 2007, you'll get the maximum 4 credits you can earn in a year. Accumulate 40 credits (which would take at least 10 years of working in jobs subject to Social Security taxes) and you'll cross the threshold for retirement benefits.

After you have 40 credits, more credits won't affect your retirement benefits. Social Security next looks to the 35 years of your life with the highest earnings. The amount of your benefits will be based on your earnings in those years. You can get an idea of how much your benefits will be from the annual statement you get from Social Security. (In early 2011, the Social Security Administration unwisely announced it would stop sending annual statements, and that by the end of 2011 or early 2012 it would unveil a system for citizens to get Internet access to their account information; we'll see.) Or you can use the benefits calculators at Social Security's website (www.socialsecurity.gov/planners/calculators.htm).

Why does this matter? For people who have full careers of 30 or more years, it probably doesn't matter much. But understanding Social Security retirement benefits may be important for people who work substantially less than 30 years. Let's say you started working full-time in your 20's but then took a number of years off to raise children. If you have 32 credits, you're not entitled to any benefits. Understanding that you need to earn a modest amount of earnings for a couple of years to reach the threshold for benefits is now an important piece of information. With 40 credits, you could collect a few thousand dollars a year in benefits, even you've worked only ten or twelve years. That may not sound like much, but it could total many tens of thousands of dollars (or perhaps more than $100,000) over the course of your retirement years. Not bad, considering the alternative.

Bearing in mind that Social Security calculates the amount of retirement benefits based on the 35 years of your working life with the highest income, you can boost your benefits by resuming work eventually. If you've worked a lifetime total of 10 years and have your required 40 credits, you also have 25 years of zero earnings that go into the calculation of your retirement benefits. Every year you work reduces the number of zero years. Work 10 more years, and you'll have only 15 zero years and 10 more years of positive earnings to increase your benefits. The amount of the increase will depend on how much you earn, but something is better than nothing.

We'll continue with more on the mysteries of Social Security in our next blog.


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