Financial Frontlines®

This article was written by BG Gary G. Ottenbreit, Retired Brigadier General, Connecticut Army National Guard, and a new Life Member of MOAA. BG Ottenbreit is currently the District Manager for the Social Security Administration in New Haven, Connecticut, with more than 30 years of experience working in this agency.  This is his first blog post. These views are his own, and not necessarily the views of the SSA.

What is retirement? A century ago, it simply meant an event – when you opted to end your nine to five grind in the workforce. When a vast majority of the population found they could not afford that option, the government stepped in and passed the Social Security Act. Since then, the meaning of retirement has evolved into a ‘state of being’, an attainment of a certain age, financial stability. I believe that retirement has evolved sufficiently to be included as another step in one’s ‘life planning’.

As parents, we raise our children, educate them in preparation for life and then continue to offer support as we send them off into the world to make it on their own. We hope that sometime between their High School and College years they make their life plan. They make career choices, decide where to live, they may choose partners and/or raise a family and, yes, and if they are wise, begin to plan for their retirement.

For the purpose of this article, let us simply define retirement as that point in time when you are no longer in the work force. The funds you use to live your life are primarily income and not earnings. The goal, in retirement, is to maintain a life style that is equal to, or better than, the one you have grown accustomed to while you were working. It is not a question of if you will retire, but when, and planning for it will make the transition smoother. Retirement is a personal choice based on your ability to work, your choice to work or not, and your financial circumstances.

When conducting presentations, I often refer to Social Security benefit as the foundation. Social Security was designed to replace only one-third of your earnings. The other two-thirds should come from other sources; a pension from your employer, personal savings, investments, or other income. The combination of these resources will fund your retirement and if you planned correctly, sustain you as you move through them. However, the topic of this article is not Social Security – it is about how critical the savings portion is to your plan for retirement. Saving is the only building block that you can control.

A Social Security benefit and a company pension are subject to rules and predetermined formulas as are investment returns and rental income are subject to the current market value therefore, all are out of your control. However, you can control how much money you can save.

I have read articles from renown financial planners that recommend (retirement) planning a replacement rate of income for earnings at 70 to 80 percent. At retirement, to make your ‘nest-egg’ last, you should plan to withdraw only 4 percent a year. This is not an easy feat and certainly difficult to attempt to accomplish over a short period.

It is never too late to start planning for retirement. However, starting early means additional years of preparing and the less financially painful it will be to save. Saving smaller amounts, consistently over a long period, is easier than saving larger amounts of money over a short period. Just as important is tracking the growth of your retirement ‘nest-egg’. Review the year-to-date benefit projections from your retirement income instruments annually. [Analogy: You are reviewing Course-of-Actions and planning the battle.]

Waiting until mid-life to plan will probably extend the number of years you will need to work, force you to supersize your contributions and/or possibly cause you to alter your present and future lifestyle. [Analogy: The battle is half over and although you have not lost ground you have not gained any either.]

Waiting until you are within five years of retirement leaves you practically no room for improving your financial position. At best, you could rearrange your investment accounts and create a tax strategy. [Analogy: You are in retrograde.]

Visiting the Social Security website www.socialsecurity.gov can be helpful. There are many links and articles related to retirement planning. Two valuable requests that you can make online are the benefit estimate and the annual statement. The benefit estimate will not be exact, depending on how many additional years you will work, but it provides an excellent reference point. The Annual Statement lists your FICA wage by year, match the statement amounts against your pay stubs and/or tax returns for accuracy. Note: Later this year Social Security Administration will offer an Internet MySocialSecurity portal offering personalized service after the user registers with a self-selected username and password.

Contact the financial consultants from MOAA and/or USAA – I have and found them to be helpful. I stated earlier that it is never too late to start, however, the reverse is also true – it is never too early to start. Make sure that retirement planning is part of your children’s education.

The Roth Thrift Savings Plan Option will soon be available. Most agencies and services can begin accepting elections for Roth (after-tax) contributions on or about May 07, 2012. Your question might be “should I invest in Roth?” The answer may come down to whether you want to pay Uncle Sam now, or pay him later.

There are two distinct types of contributory retirement savings in 401(k) type plans, like the TSP, or IRAs – traditional or Roth. Traditional plans allow you to delay the payment of income taxes (payroll taxes – FICA and Medicare – must still be paid) on your contribution to a qualified retirement account. Uncle Sam provides an incentive to save for retirement by allowing us to postpone the tax due on those funds until we receive them. The funds are deposited into your account before federal and state, if applicable, income taxes are imposed. The funds we contributed, plus the employer match, if any, and any growth within the fund will then be taxed at our marginal tax rate upon receipt.

We may begin a penalty-free withdrawal from these tax-advantaged accounts at age 59.5. Minimum distributions are required beginning at age 70.5. This tax deferment is significant. If you believe that your tax rate in retirement will be lower than it is now, then a traditional TSP may be for you. However, many military folks will be in higher tax brackets once they lose their tax exempt allowances and their ability to claim legal residence in an income tax exempt state. Making a Roth contribution while still serving may be a smart thing to do.

No one can predict with certainty what tax rates will do in the future, of course. Let’s just agree that there is pressure to increase taxes, and that pressure is unlikely to dissipate with so many Baby Boomers entering their retirement years. Uncle is going to want to collect the taxes he’s postponed for so long.

Our other choice is the “pay Uncle Sam now” election, or Roth. There is no immediate tax break with Roth TSP contributions. The break comes later. Since all contributions to a Roth TSP are made after-tax, later withdrawals, including all growth, are tax-exempt.

Many financial planners encourage their clients to set up a stream of taxable and tax-free dollars to use in retirement. Roth contributions are a great way to do this. If you’re currently serving military, you know that you already receive a significant tax break through your allowances, primarily BAH and BAS. Can you afford to pass up another break now to receive one later? Many of you can.

What other ways can you use to receive tax-free dollars in retirement? Roth IRAs are another investment you can make. But Roth IRA contributions begin to phase out for singles making $110,000 and for couples at $173,000, and are proscribed at $125,000 and $183,000 Modified Adjusted Gross Income, respectively. Sounds like a lot of money, but with a military pay and a working spouse, or military retired pay and a good second job, many retirees bump up against those limits. The Roth TSP or 401(k) contributions have no income limits.

A few cautions. Employer matches must be applied to a traditional 401(k). That’s not an issue for military folks, but someday it might be. It is a big part of the equation when you’re in a job with an employee match – those funds can’t go into a Roth 401(k).

If you open a Roth, or split your contributions between a traditional and Roth TSP, the annual contribution limits still apply ($17,000 in 2012, plus a $5,500 catch-up contribution if you’re age 50 or more). You don’t get another bite at the apple just because you opened another account. Any employer match you might receive does not count toward these contribution limits.

Uncle Sam has given you a choice. You can pay him now or later, so do your homework and make your decision.

Detailed information on the Roth TSP is available on the TSP website.

Do you have cash value in a life insurance policy or a commercial deferred annuity and own a long term care policy? If so, it may be possible for you to use the money in your life insurance or annuity to pay for your long term care insurance without paying taxes on the life insurance or annuity withdrawal.

Normally the withdrawal of funds from life insurance cash value or a deferred annuity triggers a taxable event. The portion of the withdrawal that’s considered the ‘gain’ is taxable as ordinary income.

Section 1035 of the Tax Code has always allowed tax-free exchanges of entire life insurance and annuity policies; even tax-free partial payments between life insurance policies and annuity contracts. However, now an enhancement to Section 1035 took effect on 1 Jan 2010 that added long term care policies to the mix.

This means money from the cash value in life insurance policies or deferred annuities can be withdrawn and used to pay premiums of long term care insurance without causing a taxable event.

Keep in mind, we talking tax code here so there are catches. There are so many different types of life insurance, annuities and long term care policies that not all of them qualify. Only your insurance provider, or possibly your financial advisor, knows for sure. Retirement accounts don’t qualify—annuities within an IRA or an annuity form of pension plan.

If your policies are eligible, the transfer must be worked between the two insurance companies. They know the process and paperwork and the transaction has to be a direct transfer from one company to the other.

Besides U.S. Code Title 26, Section 1035 of the tax code, also see IRS Internal Revenue Bulletin, 2011-36, Sept 6, 2011. Your long term care insurance provider will probably be your best bet for information and action.

I don’t know about you, but just about every day I hear someone on the radio talking about Living Trusts and how they can solve estate problems.  And in a lot of cases that is true….but not always.  So, what I’ll do in this article is lay a little bit of groundwork on Living Trusts from a Financial Planning standpoint.  We’ll cover some estate basics, what a Living Trust can do and what a Living Trust can’t do.  We’ll wrap it up with a couple of scenarios where a Living Trust might be appropriate.  Here we go…

Estate Basics.   When you die, you establish an estate.  But you don’t have just one estate, you have several.

1. Gross Estate.  Your gross estate includes everything you own totally or partially.  It also includes those things in which you hold the “incidents of ownership”.  Incidents of ownership means that even though the asset isn’t in your name, you still control it.  For example, if an asset is in a trust, but you control how it is used, invested, spent or if you can take the asset out of the trust you have incidents of ownership.
2. Taxable Estate.  Your taxable estate includes everything from you gross estate minus deductions,credits and exemptions such as the unlimited marital deduction or a deduction contributions the estate makes to charity.
3. Probate Estate.  You probate estate includes all assets that transfer as directed by your will (or by state law if you do not have a will).  Things that are not included in your probate estate include:
   1. Assets owned as Joint Tenants With Rights of Survivorship
   2. Assets held in trust
   3. Assets that transfer via contract such as the beneficiary of a Life Insurance contract or Retirement Plan
4. Estate Taxes.  As of this writing most individuals will not pay federal estate tax as the current amount that you can transfer to someone other than your spouse without federal estate tax is $5 million.  This will change, if Congress doesn’t take action, at the end of 2012.  States vary.

What a Living Trust Can Do.  A Living Trust can help you reach specific planning goals such as:

1. Increase Estate Liquidity.  Assets in trust can immediately be accessed by the trustee.  There is no action required by the trustee to execute the trust’s instructions.  On the other hand, assets that pass via will require the executor to qualify with the county/state prior to doing anything with the estate’s assets.  Depending on the court workload and the executor’s availability this could delay access to the assets for weeks or maybe even a month or two.
2. Provide Privacy.  Probate proceedings are a matter of public record.  If someone desires, they can gain access to court records and gather data about the estate and heirs.  This is not the case with a trust.  A trustee has no requirement to publicly disclose the assets of a trust or the identity of beneficiaries.
3. Reduce Probate Expenses.  Probate expenses/court fees are normally calculated as a percentage of the probate estate value.  The more assets in a Living Trust the lower the value of the probate estate and thus lower fees.  Also, Real Estate passes through probate in the state where it is located, regardless of where the owner resides.  If “out-of-state” Real Estate is held in trust, the grantor eliminates the requirement and expense of probate in a second state.

What a Living Trust Can’t Do.  A Living Trust is a tool and just like any tool it can’t do everything.  For example:

1. A Living Trust can’t reduce your Estate Taxes.  If you are at risk of paying Federal Estate Taxes, a living trust won’t help you out as you retain “incidents of ownership”.  Other types of trusts can be used to reduce Federal Estate Taxes, but Living Trusts can’t
2. Anything…if you don’t fund it.  Once the Living Trust is established it must be “funded”.  That means changing the ownership of all assets you want in the trust.  You must for example:
   1. Change the deeds on real property to state the trust now owns the property
   2. Re-title vehicles
   3. Change bank accounts to be held “In Trust For”

So with an understanding of the basics, when might a Living Trust be a good idea for you?  Some instances that come to mind are:

1. Like a lot of other military members, you own Real Estate in states other than the one you live in.  In one case I worked with a military member who owned property in Nevada, New Mexico and Colorado.  That member lived in Virginia so the estate was subject to four different probate processes.  This would result in a large probate expense (expenses in each state) and a great deal of paperwork.  A Living Trust could solve that problem.
2. Privacy is very important to you.  If you don’t want anyone to have the ability to find out about your finances then putting your assets in a Living Trust will help you.
3. Liquidity is critical.  If you are providing support to a dependent that is unable to support themselves without you (special needs child, dependent parent) a trust might be indicated.  The trust will prevent your assets from being “tied up” in probate and forcing your dependent to survive without support.

These are just some examples of how a Living Trust might help you.  It might also show that the effort of funding a trust may not be appropriate in your case.

The important thing to remember about Estate Planning is that you have to be very precise.  This is not something you want to try to do on your own or with an on-line software program.  Get competent legal advice when drafting documents and consider working with a Financial Planner to make sure your Estate Plan integrates with your overall Financial Plan.

Are you a person who planned ahead and prepared legal documents such as a durable power of attorney for health care, a living will, and a power of attorney for your other personal/financial affairs? Well, if you have contact with any VA services, you would probably be well served by filling out the VA’s specific legal documents to make things really official.

You see, the VA is federal and your legal documents are based in state law. That can make things confusing depending on where you signed your state documents, what your state of residence was at the time of signature, your state of residence when you are patient, or where your treatment as a patient is administered. We military retirees are a mobile group.

The VA Advanced Directive for Durable Power of Attorney for Health Care and a Living Will is VA form 10-0137. The VA power of attorney forms to appoint a Veteran Service Office or an individual as your representative to handle a VA claim or appeal are VA form 21-22 and VA form 21-22a respectively. All are available on-line, just Google the form numbers or go by your VA office or Veteran Service Office (VSO). Find a local VSO at http://www.va.gov/statedva.htm to ask specific questions.