Financial Frontlines®

The Treasury Department’s new rules will require banks to protect amounts you receive from Social Security and the VA in your bank accounts from debt collectors and garnishment.

Laws have protected these government funds from creditors in the past, but when faced with a garnishment order, banks would freeze whole accounts.  The government funds would be frozen along with the funds eligible for garnishment.  Freezing the whole account causes financial hardships and cost time and money.  When the whole account is frozen, you have to file a claim to get your government funds released and that’s where the hardship, time and money come in.

Now the bank must determine how much you receive from Social Security and the VA.  They can only allow the amount above the government payments to be frozen and made available for the garnishment order.  Other government payments are also protected like CSRS and FERS income among others.

These rules are expected to be implemented in the fall or winter.  See the Federal Register for details.

I’m asked so often from retiring service members about whether or not to sign-up for the Survivor Benefit Program (SBP); I figure it’s time for me to put an answer down on paper.

If you are thinking I’m going to state 100% “yes” or 100% “no”, you’re fooling yourself. As in any financial product, there is no totally good or totally bad product. Everything’s a shade of gray. I have no bias for or against SBP. It’s your family, not mine. I will help you define the issues and that should drive you to a clear choice for you and your family.

First, the basics. SBP provides a survivor the benefit of 55% of your base amount potentially for life. For this article I will assume your base amount will be your entire retirement paycheck amount—you have a choice you know. You are allowed to select, with the approval of your spouse, a base amount of coverage that can start at $300 a month up to the full amount of your retirement check. Your premium is typically 6.5% of your base amount.  Your premium could be less than 6.5% if you have service prior to 1990 and you select a base amount around or less than the threshold amount.  Check with your SBP office for the current threshold amount--it’s a relatively small amount.  And yes, as your base amount increases with cost of living adjustments (COLAs) each year so does your SBP premium since the premium is a percentage of your base amount.

So if your retirement check is $2500 a month and you cover the full amount under SBP, upon your death, your spouse gets $1375 a month for life with annual cost of living adjustments. Benefit payments are suspended upon remarriage and start again should the remarriage end. Those are the basics, now let’s define the issues.

The choice isn’t between SBP or life insurance. The choice is ‘SBP and life insurance’ versus ‘life insurance alone.’ You’re going to need life insurance regardless of SBP. Chances are 55% of your retirement pay is not close to your family’s current standard of living. If you are still working, you will be replacing two incomes, your job and military retired pay. Projecting into the future when you are “retired-retired”, as we say, you will be replacing income from military retired pay, a piece of Social Security, and possibly a part-time job. That means you will need life insurance to supplement the SBP payments. The extra life insurance will cover debts and/or provide an investment that can generate an additional income. Does your spouse earn a paycheck? If so, that probably minimizes the need for either SBP or some life insurance.

SBP is dirt simple; life insurance isn’t. It’s tough to put a price on simplicity but it is definitely valuable. When the military member dies, the survivor notifies the proper pay agent and the payments begin, that’s it. Payments keep rolling in every month and receive COLAs annually. The COLA adjustments will be extremely valuable when inflation is the double digits. An inflation rate of 10% means the costs of life doubles in 7 years.  Without SBP, you have investments usually created from life insurance.  How long will your investments last if your survivors need to withdraw larger and larger amounts to afford to live?  The regular and consistent payments of SBP are a source of supreme comfort to a survivor. Life insurance is complex and requires projections that may or may not come true.

How much insurance do you need now..later? What about in 10, 15, 20 years? You buy more later, it will cost you. If you have to buy more later, will you even qualify based on the health check? Bad things happen as we age. What type of insurance best serves your needs? After you die, what becomes of the huge lump sum? Is your spouse ready and able to manage a huge portfolio and make it last for decades? Will you use an immediate annuity to create a lifetime income with the life insurance proceeds? Who can you trust to manage the money for your family after you’re gone?  When inflation hits, your investment will have to be precisely managed to increase the return and allow for larger withdrawals or your family will run out of money early.

I’ll lower my base amount to decrease my premium. Sure, you can do this. However, it’s not about you and your premiums. You’re dead! It’s about your survivors and the amount you leave them. At some point, lowering the base amount to save on the premium makes the actual survivor benefit virtually worthless. A base amount of $500 gets the survivor $275 a month. Of value or not? Only you and your spouse know for sure. The benefit should drive the base amount decision, not the premium. Keep in mind that the premium comes out of your gross pay, pre-taxed, so the take-home pay is not impacted $1 for $1 due to the premium amount. The SBP premium reduces your tax burden so a 20% income tax rate is like getting SBP at a 20% premium discount.

Social Security may or may not be available. Social Security survivor benefits aren’t automatic for every survivor. A survivor with dependent children can collect benefits for the kids until they turn age 16. If there are no children, the survivor has to wait until age 60 to start survivor benefits. A survivor could start receiving benefits because of young children then stop receiving the payments once the children age out of the program. The survivor will go without benefits once the children age out of the program until the survivor turns 60. This hole in the Social Security coverage may cause a significant gap in your financial plan.

I earned that military retired pay! Without SBP, the military retired pay you risked your future for stops at death. This alone may cause some of you to get SBP just to ensure your sacrifice does not go for naught. Your spouse also had to pay for your military service. Lost career maybe, the stress, the worry, managing a household, taking care of kids alone, basically allowing you to keep your mind on the mission and not have to multi-task with things on the home front. There’s a lot to be said about the principal that the pay should continue because two people earned it.

How much life insurance do you need? Aw, the age old question. Generally, speaking, do you want coverage for only your debts, debts and short-term income needs or long-term income needs? There could be possible estate tax issues for some of you but that’s for another day.

* Debt only option.  This option leaves no money for living, just paying debts. If you want your family to be debt free at your death, add up your debts to get a total amount for life insurance purposes. What debts? Credit cards and loans pop into mind but what about…the mortgage? Kids college funds? Money to move? Burial costs? How might this figure change over the years?

* Income for a short-term? Short-term might be $40,000 a year for three years. Just do the math.

* Long-term might be lifetime income. Suppose you want $40,000 per year with an annual cost of living adjustment into the unforeseeable future. Now things get cosmic. I oversimplify this but to provide a thumbnail guide, figure the annual income is 4% of a lump sum investment. A $40,000 annual income would require a $1,000,000 portfolio. If these amounts represent how much you need today, with a high inflation rate as is expected, you may need $2,000,000 in 7-10 years for the same buying power–if you don’t die until later.  The tricky part is that this investment will need to last potentially a long, long time; many decades. It must be properly and carefully managed. Who you gonna trust? Another lifetime income option is to use the life insurance proceeds to purchase an “immediate annuity” from an insurance company. I used the Vanguard annuity calculator to determine a $1375 monthly lifetime income can be created by purchasing an immediate annuity with $470,000. It takes about $820,000 to generate a $3300 monthly income with an annuity.  Got that much life insurance or other assets you are willing to plunk down on an annuity?

How long will you need life insurance? The default answer is until you have enough in other assets to live on. Then the life insurance is no longer needed, theoretically. How long will that be? How much do you have in assets now? What’s your game plan for reaching the magic amount? How’s that game plan working so far with the economy and the markets? What happens if you lose a job for a while? The last thing you want to happen is having your insurance run out and your investment game plan didn’t work out. Guess you’ll be working a while longer. How’s that health?

Life insurance is cheaper than SBP. That may be true…but not always. We started with an example of $2500 military retired pay creating a $1375 benefit check. That benefit is $16,500 a year in income. That amount of income would require an investment portfolio of at least $415,000 ($16,500 / 4%); IF managed properly of course. Or, from my example above, a $470,000 investment in an immediate annuity. You may be able to find $500,000 in life insurance for less than the cost of $163 a month in SBP premium ($2500 x 6.5%). It all depends on your age, health, type of insurance, and length of insurance coverage.  What about generating $3300 a month ($40,000 yr)?  Now you need a $1,000,000 portfolio.  That monthly amount is from a $6000 a month retirement check or $390 a month in SBP.  An SBP payment of $3300 a month to a survivor will grow to $7800 a month in 10 years if future inflation averages 9%.  Will your investments allow an eventual $7800 mo/$93,600 yr withdrawal and not run out of money early?  The SBP COLA adjustment is a significant value that must be figured in the premium–its value will be hugely appreciated by survivors in high inflationary times.  This benefit is possible due to the heavy subsidies provided by the government for the SBP. 

That’s quite a bit to chew on. You and your spouse need to do a little role playing to put yourselves in the right frame of mind. To set the stage, the retired military member is dead along with the salary from the current job and the military retired pay. How will the remaining family survive financially; now and in the future? The best case scenario is the retired military spouse dies after the family has built enough wealth to continue at full financial strength. Worse case is death with no or little family assets. Keep in mind that even the best plans to build assets and wealth can go astray and at the very least it takes decades to built real substantial wealth. Money may not buy happiness but it sure buys security.

Medicare.We are receiving many calls from retirees about their Social Security retirement payments decreasing. This payment decrease can be traced back to the increase in Medicare Part B premiums. Medicare Part B premium increases apply to higher income beneficiaries with a modified adjusted gross income greater than $85,000 for individuals and $170,000 for couples in 2008. The Part B premium increases also apply to new enrollees in Medicare-Social Security but you obviously don’t notice an premium increase since this is your going-in rate. If you don’t see a premium increase and the resulting decrease in your Social Security payment, you are one of the 75% of Medicare enrollees unaffected by this change because you didn’t meet the income requirement.

Retired Pay. The decrease in military retired pay for some continues to be a popular topic. This is due to the 2009 Stimulus Plan expiring. Last year retirees received a break (decrease) in your federal withholding tax in military retired pay. The withholding tax reduction expired for 2010 so the withholding taxes went back up. For most, this is around $17. That’s the cause of the decrease in retired pay. Chances are you didn’t see a change if you submitted a specific amount of withholding tax to your pay agent (DFAS for most) on an IRS form W-4. The increased withholding taxes are in the tax tables under the categories like “single” or “married filing jointly.” When you stipulate a category, your withholding is determined by the tax tables that changed due to the Stimulus Plan expiring.

Military Eligible for Income Tax Filing Extensions. If you serve outside the U.S. or in a combat zone, you qualify for extensions in filing your income taxes. For outside the U.S., you qualify for an extension if you are outside the U.S. on the due date of the return. You can receive a 2 month extension. If you want more time, file an IRS Form 4868 and check block 8 for out of the country for 4 more months. If you’re in a combat zone, you have an extension for the time served in the combat zone plus up to 180 days starting the day you leave the zone. You could qualify for a longer extension depending on when you left for the combat zone. Assessment and collection deadlines will be extended and you will not be charged interest or penalties attributable to the extension period. The deadline extensions also apply to individuals serving in the combat zone in support of the U.S. Armed Forces, such as merchant marines serving aboard vessels under the operational control of the Department of Defense, Red Cross personnel, accredited correspondents, and civilian personnel acting under the direction of the U.S. Armed Forces in support of those forces. Members of the U.S. Armed Forces who perform military service in an area outside a combat zone qualify for the extension of time provisions if their service is in direct support of military operations in the combat zone, and they receive special pay for duty subject to hostile fire or imminent danger as certified by the Department of Defense. You are able to notify IRS directly of your request for combat zone relief for extensions of deadlines through a special e-mail address: combatzone@irs.gov. For more info on these tax filing extensions see this IRS page.

Even if the inflation rate is in negative territory this year, Social Security income will remain stable but…it is possible some of you will have less Social Security income in your pockets.

This can occur if you are new to Medicare in 2010 or if you are in the upper income groups of Medicare Part B and D premium rates. Part D probably won’t be a factor for most since military retirees don’t tend to have Part D.

New Medicare enrollees pay the rates in effect at enrollment. If you enroll after a rate increase, you pay the higher amount. The result is your Social Security income remains stable from 2009 to 2010 but you pay higher Medicare premiums than the 2009 people did.

Part B premiums are due to increase for the upper income groups. With no COLA increase expected for Social Security and a Part B premium increase for upper income groups, your Social Security take-home pay will be less than last year. The upper income group is defined as those with incomes above $85k for singles and $170k for couples.

Wow, this program has caused quite a state of confusion and for good reason.

The tax withholding reduction (up to $400 for individuals or up to $800 for couples) applies to “earned income”–people still earning a paycheck with an employer.  They will have their payroll taxes reduced and at the end of the year receive a tax credit for the reduced amount.  So you pay fewer taxes now (more pocket money) and won’t owe the tax later.  Each wage earner in the family may have this reduction applied to them by their employer.  However, the dual income family can apply only one tax credit at the end of the year for up to $800 per joint tax filing. 

Retiree checks are not eligible for this program.  However, retiree checks use the same tax withholding tables as paychecks.  So our retiree checks will reflect the tax withholding decrease.  That means you either increase your withholding to compensate for the withholding reduction or be ready to possibly owe more taxes when you file your 2009 income tax returns.

If you also receive Social Security and/or VA Compensation, you will receive a one-time lump sum amount of $250 in one of your monthly checks in the next few months.  If you also work and receive either VA or SS checks, that means you receive the payroll tax withholding reduction AND the $250 lump-sum HOWEVER the $250 will be subtracted from your payroll tax withholding credit. 

IRS site: http://www.irs.gov/newsroom/article/0,,id=204447,00.html

DFAS My Pay site for tax withholding changes: https://mypay.dfas.mil/mypay.aspx

Hope this helps.