When to claim Social Security

Posted on April 12, 2012April 12, 2012 by Danielle

Modern Social Security card. (Photo credit: Wikipedia)

Ask just about any fee-only advisor when you should claim Social Security and most of us will jerk our knees and tell you, “70”. Then, you’ll go out and do it early—approximately 43% of men and 48% of women take their benefits at 62. So nobody is listening to financial planners? Why are planners clueless on this?

We add numbers, and we know that you’ll collect approximately 1/3 more for each period you wait—1/3 less at 62 than 66, 1/3 more at 70 than 66. The difference between 62 and 70 is huge. So, let’s look at the dumb reasons people take it early (I’ll get to the smart reasons in a minute).

I want to get it now because Social Security is going broke. Oh come on, I’ve been hearing that one since I was in grad school, which was a long, long time ago. So you vote? Do you know the clout of the AARP? Do you seriously think there is a sole politician who could get elected in this country if he voted to eliminate Social Security? Yes, there will be changes in the future, but if you’re old enough to be able to collect or accurately estimate your current payments, I think you can get off the crazies bandwagon.

I could use the extra money. In some circumstances, I think this is actually smart (see below), but most people I see who use this excuse have a lot of budget problems, and would be better off addressing these through spending alterations. The saddest cases are when they or the spouse are actually working and they get to give back much of it to taxes while ALSO permanently lowering benefits.

I might not live long enough—so I’ll get the money now. One of the reasons Social Security is going broke is that people are beating the system as originally designed—they’re living much longer than the break-even point. For most people that break-even is early to mid-70s. If you have a serious or terminal disease or both your parents dropped dead from heart attacks at 50, maybe I can go along with this. But if you had a parent who lived past 80, and you don’t smoke or suck alcohol through a straw, you’ll probably live long enough for your kids to take your car keys away. Especially with the “advantages” of modern senior care.

Social Security isn’t worth that much anyway. Let’s take a look at a real life example. Joe Blow has done all right at his career, but he isn’t quite ready for that villa in the South of France. His full-retirement-age monthly SS payment will be $2,158/month. If he takes it at 62, the payment goes down to $1,535; if he waits till 70, he nails $2,984/month. So Joe tells me, I’m going to go for 62 and I’ll just withdraw the difference from my portfolio. How much more dough does Joe need in his portfolio? $186,900. If Joe waits until 70, the payout will be nearly double and his portfolio would need to be $434,700 bigger to equalize the draw. For most people, this would make a meaningful difference in lifestyle.

I’ll draw early and just invest it. I’ll believe it when I see it. Actually, I know of someone who did do this. He “invested’ it in a money market account. So, if you’re thinking of this, in order to equal the benefits of the escalating Social Security benefit you need to find a return of about 8% guaranteed, plus guaranteed cost of living increases. Let me know when you find that one, okay?

I hate this job. If you’ve lasted 62 years, you might be able to last another 3 or 4. Do you hate it $400,000 worth?

Okay, I’ve had my fun. Are there any good reasons? A few.

You really are sick. If you have an acute or chronically debilitating disease where the life span is limited, especially if you’re single, you may as well claim. However, if you have a spouse this may permanently reduce spousal survivor benefits, so be sure you’re weighing all the possibilities.

You’re out of work and there’s just no other place to turn. A lot of people find themselves in that situation lately. But if you find a job in a year or so, you’ve made a decision that won’t look so good in retrospect. Try everything else before you tap Social Security.

You have children who can get dependents’ benefits. This is a situation where you may actually need the money more now than later, especially if those kids are moving toward college.

Taking the money now would allow you to tap less of your portfolio in the early years. I’m skeptical, because as I discussed above, Social Security increases faster than your portfolio will in this economic climate, but in some cases it might work, as in the case of older parents with children entering college or people who want to travel now but will be willing to watch Netflix for the subsequent 25 years.

You’ve made other investments that will not or cannot pay off until you are much older. You have a partnership, or longevity insurance or some other exotic situation which will make up the difference in the future. You’re still giving up money, but it might be a worthwhile trade off.

If you have other reasons for or against, I’d love to hear about them. When so many people decide contrary to the best numbers-assessment, there must be good reasons. I’d love the input.

Saving for college–buy your kid a house instead?

Posted on April 6, 2012April 6, 2012 by Danielle

Hangmans Noose Final (Photo credit: Wikipedia)

Maybe my needle is stuck lately, but facing the actual bill in the mail focuses your mind like a hanging (with apologies to Dr. Johnson). So, here’s some further tips and strategies on how to think about college costs.

If this is a present or future concern for you and your family, please do go back over my blog posts on this site for further information about estimating costs, and discussion of savings strategies.

First, don’t believe the costs that the College Board lists as “average”. They’re talking about some goofy number that has no relation to what you’re actually going to pay (just like the “average” cost of a nursing home stay or the “average” sale price of homes in your area.) So let’s do a little comparing. They state the average cost of attendance at a state university (including room and board) is $21,477. The University of Illinois is $29, 022 for in-state residents in 2012. Okay, maybe another $7,000 is chump change (over 4 years that’s a difference of $28,000), but my guess is it might make a difference to the plans of some people.

Now here’s where we get a little funnier. CB states that the average cost of a private four year college is $42,224. Which you might actually get close to, until you get into the “selective” range, where you’re in the $58,000 range (not counting flying your kid back and forth for fall break, Thanksgiving, Christmas break, spring break, and back home again for the summer).

Multiply those figures by 4, adding the average 6% inflation rate of college costs, and you’re looking at better than a quarter of a million dollars for one kid. I pity you if you were so unenlightened as to actually have more than one. And heaven forbid if they’re both smart. (Even there I have advice. If you think you’ll qualify for aid, have your kids close together. If you won’t qualify, have them far apart. Be sure you know the answer to this before you even get pregnant. As if.)

Think about it this way—it’s the equivalent of buying each of your children a house. But most houses are bought with 30 year mortgages—at best, you’ve got an 18 year “mortgage” on college funding. And do you currently save 47% of your income? Ahem, that’s what colleges think you can come up with when Junior is away from the home refrigerator.

Often I hear the criticism that colleges penalize savers by not only dinging income, but vacuuming up assets as well. However, if you are low enough income to be eligible for financial aid, in most cases I’d guess that you’re not really going to be able to save a whole lot, especially outside of retirement accounts. But there’s another wrinkle to this that I really, really wonder about: so-called need-blind admissions.

Most selective colleges say they have need-blind admissions. Seriously? For one thing, there’s a box on the Common App that you need to check if you’re applying for financial aid, so every admissions office can see that immediately. Given this year’s horrendously competitive application stats (20 to 1 chances at many selective schools), it defies reason to think that, given two EQUALLY qualified candidates, a school wouldn’t pick the one who won’t cost them anything. Maybe I’m wrong about this, but if I were evaluating 30,000 applications for 1,500 slots, I’d be looking for quick reasons to eliminate people.

Being “penalized” for saving is a lot less painful than having to pull $58,000 out of your paycheck, at least for most middle to upper middle class parents. Or put another way, say you make $120,000 a year. Bing, no financial aid, anywhere. Let’s say right now you’re saving 10% and struggling to keep the lights on and the (underwater) mortgage paid—you’re spending $108,000 a year. But, paying at Private U, you’re now going to be living on $50,000. Can you do it? If the answer is actually yes, then why aren’t you doing it now and saving the rest? I thought so. With no college savings, that $58,000 is going to come out of retirement accounts, a home equity line of credit (if you can get one these days) and a whole lot of loans. So, how much are you being penalized in that case?

I’m certainly not against striving for a fine education, but just like retirement savings, the earlier you start, the less you have to come up with at the last minute.

Is there anyone who doesn’t need to save? I can think of a few:

people who are or expect to be professors at universities where their children can get tuition reductions or which have reciprocal relationships with other colleges;
people who get a major inheritance early in life or have enough investments at a young age that the account can be expected to grow on its own
people who expect to downsize their housing the moment the child leaves, and have significant equity that they don’t mind using for college
people who are positive their income will remain at less than twice the cost of their child’s probable college and whose only investments will forever be retirement accounts

Not you? Time for my favorite closing line: you need a plan.

College financial aid: need and merit

Posted on March 29, 2012March 29, 2012 by Danielle

Advertisement for the Mount Carroll Seminary from 1888, mentioning the available financial aid. (Photo credit: Wikipedia)

If you have a senior in high school, March is the cruelest month. And if you have younger kids, here’s a preview of what you’re in for—fasten your seatbelts.

Some colleges and universities are kind enough to do rolling admissions—you send in your stuff and within some reasonable time you get the thumbs up or thumbs down. I’m not going into all the details of early action, early decision, single application early action—really, what are they thinking? But lots of schools save their “good news” for the last two weeks in March, which leaves nearly every college bound senior twisting in the wind since the applications were submitted for early January deadlines.

I just watched an hour interview on the Wall Street Journal where some really high powered admissions directors were forced to admit that all the stuff they use as criteria has no real predictive power. Okay, so before I start foaming at the mouth, I’m going to try to get to the financial point of all this. Financial aid formulas? Well, really, there is no formula!

I’ve written other posts on estimating your college aid, but the most common misconception I hear is that there is one formula for state schools and those private schools that only use the FAFSA, and another formula based on the CSS Profile. Not true. Not entirely, at least.

State schools are processing so many applicants and have so little non-governmental money that yes, the aid you get is pretty much based on the FAFSA, and if you’re remotely middle class, you’re going to be footing the whole bill. Luckily, that bill isn’t yet in the stratosphere, at least not in relation to costs at private schools. In relation to your personal budget, you might feel a flutter in the ole’ ticker, because the FAFSA is going to expect that you can pay 47% of your income for college costs. For the 99% of families for whom saving even 10% of their income is a challenge, well, feel your heart pounding a little?

Now, every dumb college planning article I read gives the dumb advice that the cost of attendance can be lower at a private school than at a public, because maybe, just maybe, little Jack is a stellar quarterback or little Jill just published her first novel. What’s the truth? Yeah, maybe your kid will get an alluring financial aid package if 1)you’re pretty broke 2)the kid is a genius and 3) AND HERE’S THE IMPORTANT ONE: your kid is a contender for an Ivy-league type school but is willing to settle for the third tier. Even if your kid is a genius, ivy-type schools turn down tons of those kids every day—they don’t need to give merit aid because every kid who has survived the admissions gauntlet would qualify for merit aid (and a lot of the ones they turn down, too.) Confining aid awards to needs-only gives them a little economic and minority balance—they already have plenty of wealthy applicants who’ve been tutored since preschool and who have parents who can and will pay absolutely anything to get the fat envelope (or now, the congrats email). When your freshman class is 1,500 and you get 20,000 applicants for it, the admissions department isn’t exactly a buyer’s market. So if your college payment plan is that Jack or Jill is going to get scholarships, I hope their name is Christopher Paolini (oops, he didn’t go to college).

Next overlooked fact—there’s no CSS/Profile formula. Each private school is absolutely free to give away any money, or determine “need”, any way they want. Unlike Fed money (given away on the FAFSA formula), private schools can consider your home equity, your retirement funds, or the car you’re driving. Or not. So, to get a real sense of this, go to this page and type in the specific school your child is considering. Heck, you’re probably up all night worrying anyway, so type in a few and you’ll see quite a difference, even among very competitive schools. Plug in your specific information (get your tax return and investment statements) and you’ll see how differently the same assets and income will be treated.

And now you know the most important thing: it’s time to get a financial plan.