Will Your Social Security be Reduced by the Windfall Elimination Provision?

As many of you may already know, the majority of Police Officers and other public employees in Ohio do not pay into Social Security.  However, you may have had previous work in the private sector or continue to work part time jobs where you are paying into Social Security.  If you are going to receive a pension from a job not covered by Social Security, but have paid enough Social Security to qualify for a retirement benefit, your benefit will likely be reduced by the Windfall Elimination Provision (WEP).

How does Social Security work?

Social Security benefits were created to replace only a percentage of a worker’s pre-retirement earnings. It is set up so lower-paid workers would get a higher return than highly paid workers. For example, lower-paid workers could get a Social Security benefit that equals about 55% of their pre-retirement earnings. The average replacement rate for highly paid workers is only about 25%. 

To understand why this is, you need to know how your Social Security benefit is calculated.  Your benefits are based on your average monthly earnings adjusted for inflation.  Then, they separate your average earnings into three amounts and multiply the amounts using three separate factors.  In the case of a worker who turns 62 in 2012, the first $767 of average monthly earnings is multiplied by 90%; the next $3,857 by 32%; and the remainder by 15%. The sum of the three amounts equals the total monthly payment amount.  The 90% factor is the most important and is what can be reduced by the WEP.

How does the Windfall Elimination Provision affect my benefit?

First, we need to verify that you are eligible for Social Security benefits.  The government no longer mails statements to those under the age of 60 as a cost cutting measure.  However, you can access your benefit calculation on the www.ssa.gov website by creating a user name and password.

Generally, you need 40 “credits” to be eligible for benefits.  In 2012, you receive one credit for each $1,130 of earnings covered under Social Security, up to the maximum of four credits per year. Each year the amount of earnings needed for credits goes up slightly as average earnings levels increase.  We here at Lineweaver Financial can calculate your earned credits for you.  

The WEP reduces the “90% factor” discussed above.  In the example in the previous section, instead of multiplying your first $767 of earnings by 90%, you would multiply it by only 40%, thus reducing your benefit by $383.50.  In 2012, if you retired at age 62, $383.50 per month is the maximum your Social Security benefit could be reduced by the WEP.

Exceptions to the WEP

There are exceptions, however.  If you are receiving a relatively low pension, the WEP cannot reduce your Social Security benefit by more than 50% of your pension.  So if you were to receive a $500 per month pension, the maximum reduction to your Social Security benefit would be $250 per month.  WEP does also not affect survivor’s benefits.

There is also the “Substantial Earnings” test.  If you have 30 or more years of Substantial Earnings under Social Security, you won’t be faced with the WEP at all!  Unfortunately, this isn’t an easy task for public employees to accomplish.  To pass the “Substantial Earnings” test in 2012, you need $20,475 of earnings under Social Security; however, in 1990 you only needed $9,525 in covered earnings. Also, if you have between 20-29 years of substantial earnings, you will face less of a reduction from the WEP, with each year of substantial earnings having a different reduction percentage.  Lineweaver Financial will be glad to help you calculate your “substantial earnings.”

Start planning now

Everyone can be affected differently by the WEP and other provisions regarding your Social Security.  The key is to plan ahead and seek advice from a professional if you want help.  We try to educate individuals of all ages, and these provisions can affect many people in the public sector.  With all the changes you are experiencing with your public pensions and work environment, it is important to be well educated and well versed on how you can proactively plan a comfortable retirement, regardless of how old you are now.  If you’d like more information or a complimentary analysis, feel free to give us a call.

Source: ssa.gov
Lineweaver Financial Group
9035 Sweet Valley Drive
Valley View, OH 44125
216.520.1711
www.OhioRetire.com
Securities Offered Through Sigma Financial Corporation. Member FINRA/SIPC

Saving for College? Does a Roth IRA or 529 plan fit the bill?
A Roth IRA can be used as a retirement planning tool and an education funding tool.

Parents who want to save money for their own retirement and save money for their children's college expenses have many complicated and competing choices.  One of the most basic, but most important, decisions is where to invest the money.  For example, parents who want to protect their savings from taxes can choose among 529 college savings accounts and Roth IRAs.  Both types of accounts require investors to contribute after-tax money.  However, many people do not realize that both 529 plans AND Roth IRAs allow tax-free withdrawals of contributions for children's college expenses.  But there are many key differences, including state tax liabilities, limits on who can use them, financial aid ramifications, and investing options.

Contributions to both Roth IRAs and 529 Plans are not deductible for Federal Income Taxes, but 529 contributions may be partially deductible at the State level. Contributions to an Ohio 529 plan of up to $2,000 per beneficiary per year (any filing status) are deductible in computing Ohio taxable income, with an unlimited carry-forward of excess contributions.  The withdrawals of the contributions from both accounts are tax free.  The earnings or profits spent on college tuition come out of the 529 plan tax free; in the Roth IRA, if you are under 59½ and haven't waited five years since contributing, the earnings may be taxable.  If thinking about using the funds for education expenses other than college, i.e.,  private high school, the 529 plan might not be the best bet.

Another nuance between the two plans involves your ability to contribute to each plan.  The 529 plan has very high annual contribution rates and contributions are not limited by your income level.  Contributions to a Roth IRA are limited by your income to the point where those with higher incomes may even be phased out and unable to make any contributions.  The annual Roth IRA contribution rate for 2012 for those less than age 50 is $5,000 per parent.  Those age 50 and over are eligible for an additional $1,000 per year contribution.   A definite benefit for police officers is that contributions to a Roth IRA are not offset by any deferrals to your 457(b) deferred compensation plan.  If you fall within the income guidelines, you can contribute to both. 

When applying for financial aid, the treatment of both accounts when calculating the Expected Family Contribution (EFC) is treated entirely different.  A Roth IRA does not enter into the calculation of the EFC; a 529 does. Effective with the 2009-10 academic year, the value of all 529 college savings plans, prepaid tuition plans and Coverdell education savings accounts owned by a parent or by the parent’s dependent children must be reported as a parent asset on the FAFSA.  For this reason, many consider a Roth IRA to be the better planning tool when trying to maximize financial aid.  Parental assets are assessed at a maximum 5.64% rate in determining the student's Expected Family Contribution (EFC).

The surprise for many parents is the potential financial-aid penalty of using a Roth IRA: The entire IRA distribution, taxable or not, must be included in base-year income on the student's federal financial-aid application for the following year.  This can reduce the amount of future need-based financial aid. Qualified distributions from a 529 do not count as income or a resource for future calculations.

When we have a client open a 529 plan, we always suggest they let other family members know that at gift giving time other family members can contribute to the college funding of the intended beneficiary. That is definitely one drawback with using a Roth IRA for education funding; others are less likely to contribute to your Roth IRA.

Before deciding between using a Roth IRA or a 529 Plan as a college funding tool, you want to understand all of the details: how you put money in, how you take money out, and how the ins and outs are treated for tax and financial aid calculations.  If you have questions on whether a Roth IRA or a 529 plan is best for you, give Lineweaver Financial Group a call 216.520.1711, and we’d be happy to provide complimentary advice based on your situation. 

Lineweaver Financial Group
9035 Sweet Valley Drive
Valley View, OH 44125
216.520.1711
www.lineweaver.net
Securities offered through Sigma Financial Corporation. Member FINRA/SIPC

Interest rates on most savings vehicles have been and will probably continue to be at record low levels for the foreseeable future. The Federal Reserve Bank has given indications that they are in no hurry to raise interest rates, for fear it could stall the weak economic recovery. According to Bankrate.com, money market rates in the Greater Cleveland area are in the .05%-.20% range. My guess is that your CDs aren’t doing much better; according to Bankrate.com rates on 2 year CDs at banks in the Cleveland area are running in the 1% to 1.25% range.

For those of you who are in DROP, or considering entering it in the future, you need to be aware of potential changes. While DROP is currently earning an attractive 5% according to the Ohio Police & Fire Pension, this rate could change. The Ohio Police & Fire Pension is considering using the 10 year U.S. Treasury rate as a benchmark for the yield in DROP. With 10 year Treasuries currently yielding 2.1% according to the U.S. Department of Treasury, that is a significant change.
Other than rising healthcare costs and college tuition, we haven’t paid much attention to inflation over the recent past because it has been relatively moderate. Things have changed--with energy costs, grocery prices, and everything else going up in cost, more attention is being paid to inflation. Over the last 12 months, the Consumer Price Index for All Urban Consumers (CPI-U) increased 3.6%.

Now let’s couple low interest rates with inflation. I don’t want to make your blues worse than they already are, but to make your savings rates look worse, you really should factor in inflation to arrive at your cost-adjusted rate of return. Let’s look at an example: if you had $500,000 in DROP, earning 5% with inflation averaging 3%, and each year you withdrew your interest, at the end of 10 years you would still have $500,000 in DROP. But due to the impact of inflation, the purchasing power of that $500,000 would only be about $369,000. Now you see the bite inflation can have on your savings. Think of the impact if the interest rate in DROP drops to the 10 year Treasury rate.

If your income increases at a rate exceeding inflation, then your monthly budget isn’t getting squeezed; but if inflation is greater that the increase in your wages and other sources of income, you are losing ground. Are you retired and on a fixed budget? That could mean financial stress now and for years to come!
Thinking about making changes in your holdings to gain more interest and stay ahead of inflation? Make an educated decision before you make any moves. Let’s look today at two general assets classes and how they cope in periods of inflation.

Stocks have the potential for growth. As companies face increasing material or labor costs they can pass these increases onto their consumers and maintain their margin of profitability. Many stocks have dividends and a track record of steady dividend increases at a rate greater than the rate of inflation. A type of stock, preferred stocks, have fixed yields that would be viewed as an alternative to conventional fixed income investments.

For many investors, especially those in retirement, bonds serve a great need in their portfolios. Bonds may help create a steady income stream that replaces the paychecks that ended with retirement. However bonds have historically not been a good hedge against inflation. The interest on a bond is not indexed to inflation--it does not increase as time goes on, and the purchasing power of the income is reduced because of inflation. Let’s say you have a $1000 bond with a 5% coupon that matures in 10 years; today the income will buy $50 worth of goods and services. In ten years, assuming you still own the bond, you will still get $50 in interest, but it won’t buy the same amount of goods and services it did back in 2011.

Likewise, when the bond matures you will get your face amount, $1000. But it will not buy $1000 worth of goods and services because your principal isn’t indexed to inflation. You are being repaid in deflated dollars. If inflation were to be 3% over the ten year period you held this bond, you would get repaid in dollars that would only buy about $700 in goods and service.

Bonds are subject to interest rate risk; as interest rates rise, the value of bonds tends to move in the opposite direction and decline in value. However, this interest rate risk can be eliminated if you plan to hold the bonds until they mature.

Insurance companies frequently have time deposits, or fixed annuities, which offer rates which may exceed competing time deposit vehicles. A tradeoff is that you will probably limit your access to those funds while they are earning a higher interest rate.

Inflation is just one of many factors you should consider when evaluating investment alternatives. You cannot overlook other considerations--including risk, income needs, and taxes, just to name a few. Your portfolio should be constructed with the needs and constraints of your individual situation in mind.

Don’t let low interest rates coupled with rising inflation get you down! Remember, before you make a change to get higher yields, make sure you fully understand the impact the move could have on you. If you would like to discuss any move you are considering, give Lineweaver Financial Group a call at 216.520.1711 to arrange a complimentary consultation available to all OPBA members.

Lineweaver Financial Group
9035 Sweet Valley Drive
Valley View, OH 44125
216.520.1711

Securities offered through Sigma Financial Corporation. Member FINRA/SIPC
Rate of return is for illustrative purposes only and is not indicative of any particular investment; your results will vary. Past market performance is no guarantee of future investment performance or success.

None of us look forward to April 15^th, that day when all of us that pay taxes are supposed to have our tax returns completed and in the mail. To make tax season easier, start accumulating all of the documents you are going to need to prepare your return. Most of the documents like your 1099s, W-2s etc. will be arriving in the mail soon. The sooner you start to get organized, the less painful the process will be.

Here are some things that are new or have changed for the 2011 tax year we want you to be aware of.

The most important point to remember is that last year's 11th-hour tax changes, though favorable for most, are temporary. After 2012, many provisions are set to snap back to what they were before 2001, and a few even expire this year.

The contribution limits for retirement accounts did not change in 2011; none the less you should be aware of the limits and max out your contributions when possible. For 2011 the limits on IRA contributions are $5000, and for those 50 and older in 2011 the limits are $6000. This applies to both traditional and Roth IRAs. The limits for employee contributions to 401(k)s and 403(b)s for 2011 for those younger than 50 is $16,500, and those 50 and older they are allowed an additional $5,500 catch up contribution for a total employee contribution of $22,000. If you have the ability to participate in a 457 plan, you can contribute $16,500, if you are 50 or over you can make a catch-up contribution of $5,500, and if you are three years from retirement you may be able to take advantage of a special catch-up provision of $33,000 if you have not fully utilized the maximum contributions available to you in previous years. Those contributions needed to be made by December 31st; it’s too late if you didn’t make the maximum allowable contributions, but a good time to increase your contributions for 2012.

Rates continue at historic lows for both long-term capital gains and dividends. For taxpayers in the 15% income tax bracket and below, the rate is zero. For those in the 25% bracket and above, the rate is 15%. Those rates expire at the end of 2012. If you have appreciated securities that you are thinking about selling, it might be wise to sell some this year and some next year.

The system has been overhauled for Estate and gift taxes, with a top rate of 35% and one exemption of $5 million per individual for estate, gift and generation-skipping taxes alike. For those who can stand to part with assets, it's now possible to shift large amounts of wealth. The rate and exclusion expire in 2011.

The annual exclusion for tax-free gifts remains $13,000 per donor. A giver may make an unlimited number of $13,000 gifts, as long as they are to different individuals. Gifts of tuition and payments for medical care also are exempt.

The income limit for conversions has been permanently removed, so this year all taxpayers may still convert ordinary IRAs into Roth IRAs. But taxpayers who convert to Roth IRAs in 2011 no longer have the option of deferring conversion income into later years, as was true for 2010 conversions.

Workers with Flexible Spending Accounts (FSAs) may no longer use pretax funds to pay for many over-the-counter medicines—aside from insulin—without a prescription. But FSA funds may still be used for other, nonprescription medical items such as crutches, contact-lens solution or a wig after chemotherapy. For a list of what is allowed by law, see IRS Publication 502.

Lawmakers extended the "25(C)" credit for energy-efficient improvements, but in a way that will be useful to few. The amount of the credit has shrunk to a maximum of $500 per taxpayer per lifetime, so those who took last year's $1,500 credit under this provision don't qualify. The current version expires at the end of 2011, and builders and remodelers may push either to expand it or drop it altogether.

Also renewed at the last minute were the $250 deduction for teacher classroom expenses; a deduction for state sales taxes in lieu of the state income tax deduction; and the tax-free donation of IRA proceeds to charity. They expire at the end of 2011. The American Opportunity Tax Credit of up to $2,500 for education expenses was renewed for 2011 and 2012.

For 2011, the maximum amounts available as a medical expense deduction for long term care insurance premiums have increased by about 3%. The deduction limits which are based on age are as follows:

Age 40 + younger                             $ 340

Age 40 but not over 50                             $ 640

Age 50 but not over 60                            $1270

Age 60 but not over 70                            $3190

Over age 70                                          $4210

Although these limits are for your federal return, don’t forget to deduct 100% of your long-term care insurance premiums from your state tax return.

Lineweaver Financial Group will be having an education program on tax planning. If you would like to attend give Jim a call at 216.520.1711.

Source: www.IRS.gov

Lineweaver Financial Group, 9035 Sweet Valley Drive, Valley View OH 44125

1.888.313.4009

www.lineweaver.net

Securities offered through Sigma Financial Corporation. Member FINRA/SIPC

This tax information is not intended or written to be used, by the recipient to avoid any federal tax penalty that may be imposed on the recipient. This material is provided for informational purposed only and should not be construed as tax advice. Please consult your tax advisor for advice regarding your personal tax situation.