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The Future of Social Security

As politicians debate the future of Social Security, comprehensive financial planning will become increasingly important for those seeking a secure retirement.

Social Security has long been a dependable source of retirement income for millions of Americans. Yet shifting demographics, economic challenges, and the aftershocks of the COVID-19 pandemic have raised concerns about the sustainability of the program.

In fact, the latest projections show that Social Security Trust Fund reserves are likely to run out by 2033—one year sooner than previously estimated. Unless Congress takes steps to shore up the program, beneficiaries will likely see a reduction in benefits.  

In this blog post, we’ll explore the factors contributing to a potential Social Security shortfall, as well as the financial planning strategies you can leverage to help secure your retirement.

How Social Security Works

In the United States, Social Security is a federal government program that provides retirement, disability, and survivor benefits to eligible individuals.

Employers and employees pay into the system through payroll taxes. Currently, employees contribute 6.2% of their income, and employers pay an additional 6.2% for each employee.

Meanwhile, self-employed individuals pay the entire 12.4% payroll tax. In 2023, payroll taxes apply to up to $160,200 of a taxpayer’s annual income.

Contributions go into a Social Security Trust Fund, which is used to pay benefits to current recipients. Consequently, when it comes to the future of Social Security, there’s no guarantee that the money you contribute will be available when you retire.

The Future of Social Security

Why the Future of Social Security Is in Jeopardy

Although the Social Security Trust Fund had an annual surplus of $10.9 billion in 2020, it ran a deficit of $56.3 billion and $22.1 billion in 2021 and 2022, respectively. The future of Social Security is now uncertain, largely due to a combination of demographic changes and economic factors.

First, the birthrate has fallen in recent decades amid a wave of retirements among Baby Boomers, the largest generation of workers in American history. That means there are more beneficiaries but fewer workers paying into the system to fund Social Security benefits.

To put this in perspective, there were 5.1 workers per Social Security beneficiary in 1960. Today, that ratio has fallen to 2.8 workers per beneficiary, and estimates suggest it will decline to 2.1 workers per beneficiary by 2040.

Meanwhile, the average life expectancy for Americans has increased over time.

When Social Security began in 1935, workers who started collecting benefits at age 65 were only expected to live another 12.5 years. By 2030, these projections rise to 21.6 years for women and 19.2 years for men.

Thus, not only are there more beneficiaries than workers today, but beneficiaries are collecting benefits for a longer period, on average.

More recently, the Covid-19 pandemic helped put the future of Social Security in jeopardy by prompting millions of workers to quit their jobs or forcing them into early retirement, resulting in a sharp decline in payroll taxes. An economic slowdown, persistent inflation, and weaker productivity growth have only exacerbated the issue.

How the Future of Social Security Affects Retirees

Unless Congress takes steps to shore up the program, beneficiaries will soon see their benefits decrease.

Current projections indicate that the Old-Age and Survivors Insurance (OASI) fund will be able to cover scheduled benefits in full until 2033. At that point, the program will only be able to fund 77% of scheduled benefits.  

Social Security beneficiaries may also see reduced cost-of-living adjustments (COLAs), which help maintain the purchasing power of Social Security benefits against inflation. For example, the cost of Social Security increased by 8.7% this year to account for rising inflation, according to the Wall Street Journal.

Lastly, various members of Congress have proposed raising Social Security’s full retirement age, changing the way benefits are calculated, and raising taxes to help cover the shortfall. No matter what Congress decides, the future of Social Security is likely to look markedly different than it does today.

Preparing for a Potential Social Security Shortfall

Ultimately, the future of Social Security depends on Congress’s ability to agree on a course of action. Given the potential political implications, it seems unlikely that either party would let the fund dry up altogether.

Still, waiting on Congress to shore up Social Security may not be wise, especially if you’re nearing retirement age. Instead, you may want to consider the following financial planning strategies, which can help you offset the risk of a potential reduction in benefits.

First, be sure to diversify your sources of retirement income. If you can, aim to max out your contributions to your employer-sponsored retirement plan and/or individual retirement account (IRA).

In 2023, individuals can contribute up to $22,500 to a 401(k), 403(b), and most 457 plans ($30,000 if you’re age 50 or older). You can also contribute up to $6,500 to a Roth or Traditional IRA ($7,500 for those 50 and older).

Even if you can’t contribute up to these limits, boosting your retirement savings can help you retire comfortably no matter the future of Social Security. Indeed, adding to your qualified retirement accounts each month can yield meaningful results over time—especially if you invest wisely.

Qualified retirement accounts offer certain tax advantages that allow you to grow your funds tax-free until you withdraw them in retirement. This benefit amplifies the power of compounding, which can boost your savings long-term.

If you don’t plan to retire in the near term, make sure you’re investing in stocks and other growth-oriented investments, so your retirement funds outpace inflation. On the other hand, if retirement is quickly approaching, make sure your asset allocation reflects your time horizon and risk tolerance.

Lastly, if you’re already retired, consider investing in bonds and/or dividend-paying stocks to offset a potential reduction in Social Security benefits. While these types of investments aren’t risk-free, they can still be meaningful and potentially tax-efficient sources of income in retirement.

Social Security Alternatives: Roth vs. Traditional IRA

Satori Wealth Management Can Help You Retire Confidently and Securely

While the future of Social Security is uncertain—and may be for some time—you can still achieve a financially secure retirement with proper financial planning. An experienced financial advisor like Satori Wealth Management can help you identify and implement strategies to preserve and grow your money over time, so you don’t outlive your financial resources in retirement.

To see if we may be the right fit for your financial planning needs, schedule your free RetireNow™ Checkup today. We look forward to hearing from you!

5 Powerful Questions to Ask Before a Roth Conversion

A Roth conversion can be a powerful tax planning strategy leading up to and in retirement—especially if you exceed the income threshold for contributing directly to a Roth IRA. Indeed, the benefits of a Roth conversion include tax-free distributions in retirement and the elimination of required minimum distributions (RMDs).

Yet Roth conversions don’t make sense for everyone. Thus, it’s important to weigh the costs against the potential benefits, as well as alternative tax planning strategies, before moving forward.

A Roth conversion allows you to convert all or part of your existing traditional IRA funds to a Roth IRA regardless of your income level.

What Is a Roth Conversion?

The IRS allows individuals—regardless of income—to convert a traditional IRA to a Roth IRA. A Roth conversion shifts your tax liability to the present, so you avoid paying taxes on withdrawals in the future.

Here’s how it works:

  • With a Roth conversion, you pay taxes on the amount you convert at your current ordinary income tax rate.
  • After you convert your traditional IRA to a Roth, any withdrawals you make in retirement will be tax-free if you’re over age 59 ½ and satisfy the five-year rule.
  • Since Roth IRAs don’t have RMDs, you can leave your funds to grow tax-free until you need them.

A Roth conversion can be particularly valuable in years when your income is below average, and you fall into a lower tax bracket. Nevertheless, there are a variety of factors to consider before converting your traditional retirement account funds to a Roth.

5 Questions to Ask Yourself Before a Roth Conversion

Here are 5 questions to ask yourself if you’re considering a Roth conversion:

#1: Is a Roth conversion a smart tax move right now?

In general, a Roth conversion makes sense if you expect your tax rate to be higher in the future than it is today. Thus, the most important question to ask yourself before a Roth conversion is, “Will paying taxes on the funds I convert today save me money in the long run?”

Of course, tax laws can change, and it’s impossible to predict the future. That’s why many people choose to take advantage of this strategy in years when their income is below average.

For example, if both you and your spouse work full-time, earn high incomes, and file a joint tax return, you may be in the highest tax bracket most years. But perhaps your spouse loses a large client, cutting their income in half for the year and lowering your joint income enough to temporarily put you in a lower tax bracket. In this case, a full or partial Roth conversion might make sense since your tax rate is lower than normal.

Alternatively, a Roth conversion may also be a smart tax move in years when the market is down. In most cases, your account balance will also drop alongside the market, reducing the dollar amount you convert. As a result, you’ll likely pay less in taxes than you would have before the market dropped.

While the concept of a Roth conversion may be relatively straightforward, the math can be complex. Be sure to work with a financial planner or tax expert, who can advise you on the best time to implement this strategy.

#2: How will a Roth conversion affect other aspects of my financial plan?

Depending on the amount of money you convert to a Roth IRA, your taxable income can increase substantially in the year you execute the conversion. Thus, it’s important to understand how a potential increase in taxable income may impact other areas of your finances—especially if you’re already in retirement.

For example, if you receive Social Security benefits, an increase in taxable income may trigger federal income taxes on your benefits. Currently, single filers earning more than $25,000 annually and joint filers earning more than $32,000 must pay federal income taxes on a portion of their benefits. Therefore, it’s important to know if a Roth conversion will push you over these thresholds.

In addition, an increase in your taxable income can impact your health insurance premiums if you’re in retirement.

For those who retire before age 65 and need to bridge the gap until you’re eligible for Medicare, an income boost may disqualify you from receiving The Premium Tax Credit. This credit helps subsidize the premiums lower earners pay on insurance through the Marketplace.

Similarly, retirees over age 65 may be subject to IRMAA, a surcharge you must pay in addition to your Medicare Part B and D Premiums if your income is over a certain amount.

#3: Do I have adequate tax diversification?

When planning for retirement, it’s often helpful to diversify your financial resources among various account types, including traditional (pre-tax) retirement accounts, Roth (after-tax) accounts, and taxable accounts. This can help you optimize your retirement income strategy and minimize your lifetime tax bill.

As a rule of thumb, it’s usually beneficial to have roughly a third of your assets in each type of account. So, if the majority of your assets are in pre-tax retirement accounts, a partial Roth conversion can help diversify your tax exposure.

On the other hand, converting all of your funds to a Roth IRA may push you too far in the opposite direction. While this isn’t necessarily problematic, it’s a good idea to work with a financial planner to determine your optimal mix of account types.

#4: Do I plan to transfer assets to the next generation?

One of the primary benefits of a Roth conversion is the elimination of required minimum distributions (RMDs). RMDs can increase your taxable income—even in years you don’t need them—and lower your retirement account balance over time.

Suppose you plan to leave your remaining assets to your children upon your death, for example. If most of your retirement funds are in a traditional IRA, you’ll have to take RMDs every year once you reach the applicable age (currently 73), gradually reducing its balance over time.

Even if you don’t spend your distributions, you’ll pay ordinary income taxes on them, lowering the amount you can leave your children. Plus, they’ll have to take taxable RMDs from the inherited IRA.

On the other hand, Roth IRAs don’t have RMDs. If you don’t need the income in retirement, you can let your funds appreciate tax-free within a Roth IRA, then transfer a potentially larger balance to your children upon your death. Moreover, your children can take tax-free withdrawals from the account upon inheriting it in most cases.

#5: Do I have enough cash on hand to pay taxes on the Roth conversion?

Finally, don’t forget you must pay ordinary income taxes on the amount you convert to a Roth IRA in the tax year you make the conversion. Thus, you’ll need to have enough cash on hand to pay your tax bill.

While you can pay the taxes with funds from your retirement account, most experts advise against this approach. That’s because withdrawing money from a tax-advantaged account can negate many of the tax benefits of doing the Roth conversion in the first place.

Meanwhile, if you liquidate funds from investments within a taxable account, you may end up triggering capital gains taxes. This can also diminish the benefits of converting to a Roth IRA.

Ideally, you’ll have enough cash available to avoid disrupting your investment accounts. If not, you may want to start raising cash in anticipation of a future Roth conversion.

Factors to Consider Before a Roth Conversion

Satori Wealth Management Can Help You Determine if a Roth Conversion Is Right for You

A Roth conversion can be a valuable tax and estate planning strategy. Yet due to its complexities, it may not right for everyone. Be sure to consult an experienced financial planner or tax expert to determine if this strategy makes sense for you.

Satori Wealth Management specializes in the financial planning needs of those nearing and in retirement. We can help you develop a retirement plan that considers your personal tax situation and helps you achieve your financial goals. Please schedule your complimentary RetireNow Checkup™ to see if we may be a good fit.  

5 Effective Tax Planning Strategies to Maximize Your Retirement Years

For many people, the transition into retirement is full of possibility and excitement. Yet it can also be a time of apprehension and doubt—especially when it comes to achieving financial goals. In this article, we’re sharing five key tax planning strategies that can help maximize your retirement years.

No matter how well you prepare financially for retirement, there will always be challenges that threaten to set you off course. For example, many retirees are surprised by how dramatically their tax situation changes once they stop working.

In fact, about two-thirds of retirees say if they had to advise their younger selves on a financial matter, it would be to better understand how taxes affect their retirement savings, according to a recent Thrivent survey.

Fortunately, with the right tax planning strategies, you can minimize the impact of taxes on your nest egg, so you feel more confident about reaching your retirement goals.

Tax Planning Strategies

If you’re nearing retirement, consider the following tax planning strategies:

#1: Diversify Your Savings and Investment Account Types

Generally, there are three types of investment accounts in which you can grow your retirement savings:

  • Traditional (pre-tax) retirement accounts. You contribute funds before taxes, then pay ordinary income taxes on your withdrawals in retirement.
  • Roth (after-tax) retirement accounts. You contribute after-tax dollars, then withdraw funds tax-free in retirement.
  • Taxable investment accounts. You contribute after-tax dollars and pay taxes on capital gains when you liquidate your investments.

Naturally, each type of account has its advantages and disadvantages when it comes to various tax planning strategies. Thus, you may find that diversifying your investment funds across each type of account helps you develop a more tax-efficient retirement income strategy.

Plus, in higher-income retirement years when you’re in a high tax bracket, withdrawing funds from a Roth account helps you avoid paying additional income taxes. Meanwhile, you can draw on your traditional retirement or taxable accounts in lower-income years when you’re in a lower tax bracket.

#2: Consider a Roth Contribution or Conversion in Lower Income Years

In 2023, individual taxpayers with modified adjusted gross income (MAGI) above $153,000 (or $228,000 for married couples filing jointly) can’t contribute directly to a Roth IRA. However, if your income is variable, you may want to take advantage of lower income years by contributing to a Roth or considering a Roth conversion.

The IRS allows anyone, regardless of income level, to convert all or part of your traditional IRA funds to a Roth IRA. As a result, you pay taxes on any funds you convert in the tax year you make the conversion.

Any withdrawals you make in retirement are then tax-free, and you don’t have required minimum distributions (RMDs) like you would with a traditional IRA. Thus, when it comes to tax planning strategies, a Roth conversion can be valuable as you near retirement—especially if you expect to be in a higher tax bracket in your retirement years.

Keep in mind that Roth conversions can be complex and aren’t right for everyone. Be sure to consult a financial planner or tax expert before taking advantage of this strategy.

#3: Invest in Municipal Bonds

If you’re approaching retirement, it’s often a good idea to increase your liquid cash reserves so you can still cover near-term expenses if there’s a market downturn. However, depending on where you keep your cash—for example, a money market or short-term bond funds—you may end up paying taxes on any interest you accrue.

The interest on municipal bonds, on the other hand, is exempt from federal income taxes (although you may have to pay state and local taxes, depending on the bond issuer and where you live). Therefore, investing your cash in municipal bonds can help you grow your cash reserves while generating a tax-free stream of income in retirement.

A financial professional can help you determine if this is one of the tax planning strategies that makes sense for you.

#4: Relocate to a Tax-Friendly Area

Many retirees choose to relocate or split their time between two places to reduce or eliminate their state income tax bill. For example, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming have no state income tax.

In addition, different states also provide different incentives and assistance programs for retirees, such as property tax exemptions, senior Citizens’ Credit Programs, or Elder Care services. Meanwhile, countries like Costa Rica and Portugal are tax-friendly retirement destinations and also boast lower costs of living. 

If you retire in a state that has a high state income tax rate, establishing a residence in a tax-friendly location or relocating altogether may be one of the tax planning strategies you want to consider. In most cases, you’ll need to spend at least 183 days of the year in your alternate home for the IRS to consider it your permanent residence.

#5: Consider Two Additional Tax Planning Strategies: Catch-Up Contributions and/or a Spousal IRA

Lastly, for some couples, catch-up contributions and a spousal IRA can be effective tax planning strategies as you near retirement.

If you’re age 50 or above, you can make catch-up contributions to your employer-sponsored retirement plan and IRA(s). In 2023, you can contribute an additional $7,500 to a 401(k) or 403(b) plan. Meanwhile, you can contribute an additional $1,000 to a traditional or Roth IRA.

Separately, the IRS requires individuals to have earned income to contribute to an individual retirement account (IRA). An exception to this provision is a spousal IRA, which allows a working spouse to contribute to an IRA in the name of the non-working spouse.

A spousal IRA can be beneficial in that it essentially allows you to double your IRA contributions each calendar year. At the same time, you can deduct these contributions from your taxes in the year you make them, lowering your overall tax bill.

Keep in mind there are certain limitations and income requirements to qualify for a spousal IRA. Be sure to consult the IRS’s website or a financial professional to see if a spousal IRA is one of the tax planning strategies that makes sense for your retirement plan. 

Satori Wealth Management Can Help You Take Advantage of These Tax Planning Strategies as You Near Retirement

The average retirement lasts 18 years, according to data from the U.S. Census Bureau. Unfortunately, excessive taxes can quickly eat away at your retirement savings if you don’t prepare accordingly.

Indeed, these are just a few examples of tax planning strategies that can help you minimize your tax bill in retirement. An experienced financial professional can help you develop a comprehensive plan that helps you leverage various tax planning strategies and preserve your nest egg long-term.

Satori Wealth Management has been leading clients through the retirement planning maze for 20 years. If you are approaching retirement and would like to speak with us about securing your financial future, we invite you to schedule your free RetireNow™ Checkup today.