Retire Tax Free
Avoid the IRA Tax Trap
And Win the Retirement Game
Jim Jorgensen
Smashwords Edition
Other books by Jim Jorgensen (Non-fiction)
The Graying of America
Your Retirement Income
How to Stay Ahead in the Money Game
How to Make IRAs Work for You
Money Shock
A New Way to INVEST
Money Lessons for a Lifetime
It’s Never Too Late To Get Rich
Copyright © 2012 by Jim Jorgensen
Digital ISBN: 978-1-4659-7815-8
Edited by: Josh Shinn
Formatted by: Laura Shinn
Cover Design Copyright © 2012 Laura Shinn
Smashwords License Notes:
All rights reserved. Except as permitted under the Copyright Act if 1976, no part of this publication may be reproduced, recorded, transmitted or distributed in any form or by any means, or stored in a data base or retrieval system, without the prior written permission of the author. If you would like to share this book with another person, please return to Smashwords.com and purchase your own copy.
While a great deal of care has been made to provide accurate and current information, the ideas, suggestions, general principals and conclusions presented in this text are subject to local, state and federal laws and regulations, court cases and any revisions. The reader is thus urged to consult legal counsel regarding any points of law – this publication should not be used as a substitute for competent legal advice.
Because of the dynamic nature of the Internet, any Web addresses or links contained in this book may have changed since publication and may no longer be valid. The views expressed in this work are solely those of the author and do not necessarily reflect the views of the publisher, and the publisher hereby disclaims any responsibility for them.
This book is intended to provide general information; it should not be used as a substitute for legal or other professional advice.
Chapter 1: Let’s Do the Numbers
Chapter 3: The Collapse of the Three-legged Stool
Chapter 4: Goodbye Company Pensions
Chapter 5: Hello Money-Purchase Retirement Plans
Chapter 6: How to Win the Matching Dance
Chapter 7: What Women Can Do Now
Chapter 8: How Social Security Began
Chapter 9: What to Expect from Social Security
Chapter 11: You’re On Your Own, Baby
Chapter 12: What’s Ahead for Our Retirement Years?
In our father’s generation retirement meant a company-paid pension and Social Security. But today millions of future retirees will try to get by with benefits based on their past contributions and then face the prospect of supporting older parents whose cost of care can increase quickly as they become frail and require nursing home care.
But once retired, the mad scramble for income will begin. Most retirees today live off a combination of pensions, Social Security, an employer’s 401(k) and other savings like an IRA. Over the next few years that will change. Most people will retire without a company-paid pension and will need to rely on their accumulated savings and then wait as long as age sixty-nine to collect “normal” Social Security benefits.
As a nation of early quitters, often starting at age 62, supporting themselves to age sixty-nine before regular Social Security and company benefits begin could be almost impossible unless they go back to work. Not only will they need the money, but within five years of retirement the dollars they receive from reduced benefits can shrink in purchasing power at the local grocery store. Yet, if they retire early and go back to work before “normal” retirement age [currently age sixty-six going to age 67], they can lose a big chuck or possibly all of their Social Security benefits from the earnings limit under the law.
What all this tells us is future retirees face a triple whammy: reduced Savings by employer and employee, a longer life span, much higher taxes and loss of earned benefits in retirement.
We as a nation have never faced a situation like this in our history. As a result, older Americans are increasingly going to be induced to remain in harness far longer than anyone planning retirement in their forties or fifties today ever dreamed possible. If you’re not yet fifty use this information to anticipate the future and make your plans accordingly.
I have not based my gloomy assessment on a series of assumptions on how we'll retire in the future. What I'm forecasting is the fundamental economic consequence of living longer and, at the same time, Social Security and employer retirement benefits are shrinking.
On a more personal note, this book is about the IRA Tax Trap and how Congress has induced millions of workers to avoid income taxes on the money they save for retirement. Once retired, they face a nasty surprise. Their withdrawals face not only income taxes but mean tests, increase taxes and monthly Medicare premiums based on reportable taxable income in retirement. Maybe that’s why a growing number of retirees now find that when they make withdrawals from their IRAs, 401(k)s, 403(b)s and pensions half the money they’ve saved over the years can disappear. And the outrage continues over Congress making plans to cut Social Security retirement benefits and possibly eliminating the retirement check for higher-income retirees.
You now have a clear choice: take a tax deduction for your retirement savings and later pay the taxes and face means test in retirement, or pay the taxes when you save and keep all your money in retirement.
Most of all, I’ve tried to incorporate in this book ways to help you recognize the difference between simply stashing cash in a handy tax-deductible IRA or 401(k) instead of first paying taxes on the money.
As you save for retirement never forget this message:
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Once you delay taxes the government controls everything you do and how much you pay to receive the money.
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I gave early pre-publication copies of this book to my employees and radio listeners because I was eager to explain ways to bring success in their financial lives and, for the first time, imagine themselves planning for withdrawing their money in retirement tax free.
I hope each time you read this book you’ll find something new and useful for yourself, your loved ones and your friends. I’m glad that I can share what I’ve learned and I wish you well as you build your financial future.
By the time this book appears, some of the material may be out of date. I have tried to keep the book as current as possible, fully recognizing that our nation's entire retirement system is resting on a sea of shifting sand and I might fail in this attempt. I make no claim to infallibility. In addition, to concentrate on the important points, I have purposely left out much of the detailed material that supports many of the conclusions made in this book. I believe that principles and ideas should be easy to understand so that you may not only discover what is happening today but also visualize how these developments may affect your future.
What you read in the following chapters may be shocking and frankly a little scary. It may also make some of you angry at the way Congress has run off with our payroll taxes and reduced our retirement benefits. Chances are what you read in this book is also something not talked about outside the Washington beltway.
Many of you may not agree with every conclusion I reach. The future is cloudy at best. But consider this: if I am wrong, nothing in this book will hurt you. If I am right, and you become more aware of the retirement income shortfall you could face, and that creates the willingness to understand our retirement plans and the need to save more to provide for your own retirement income, I know the book will have fulfilled its purpose.
My vision of the future has us working together, learning how we can best take advantage of the opportunities from our employer and our government and, in the end, how each person can be responsible for his or her own financial security in the future. The stakes are high, not only for our families and ourselves but for the millions of Americans who have already retired into a world of inflation and shaky pension plans.
Books are rarely written alone. I would like to thank my son Richard Jorgensen, former co-host on my syndicated radio program and who for years has unselfishly offered advice and inspiration when it was needed most.
But most of all, I would like to dedicate this book to my children and six grandchildren. They are making their own way in our marvelous country surrounded by all the freedoms we hold so dear. But as they build their own lives I am concerned about the economic problems I see coming. They will have to live in a world beset by those problems, many of them of my making. I hope and pray that the legacy I leave my children will not include economic problems that I created but failed to solve. I know America will survive.
James Jorgensen
San Francisco, California
Chapter 1: Let’s Do the Numbers
When I wrote The Graying of America thirty years ago I based my predictions on the nation’s failing pension system on four basic trends:
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• Increased life span.
• Rising salaries to meet the cost of living.
• Decreased contributions to fund skyrocketing benefits.
• Fewer workers to support retirees.
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Unfortunately, most of my predictions of the decline of America’s private and public pensions and retirement system have come true. Back in 1980 I said we had to listen to the canary-in-the-coal-mine that was telling us this was the start of reduced retirement benefits from our government, employer and from our own savings.
Today the canary has died. All of us now face massive pension plan failures leaving many people within a few years of retirement empty-handed, while others find no matter how much they pay in Social Security taxes they are likely to wait to almost age sixty-nine to receive regular benefits at retirement.
But what I didn’t expect was that private employers, state and local governments and Social Security would continue to offer hefty retirement benefits without coming up with the money to pay for them. In the pension business this is called underfunded, or a shortfall of the necessary cash to pay for the benefits already promised.
Most American taxpayers have now become aware of the trillions of dollars state and local governments have missing from their public employee pensions, but the U.S. government has the top prize for missing money to pay already promised benefits. Consider this shocking fact: the unfunded liabilities of Social Security, Medicare and Medicaid already exceed $106 trillion. That’s well over $300,000 for every man, woman and child in America and exceeds the combined value of every U.S. bank account, stock certificate, building and piece of personal or public property. In other words: already promised retirement and health care benefits amount to more than everyone owns in America today.
As I said in 1980, and it’s true today, the coming meltdown of our employer-sponsored retirement system and Social Security is based on four important factors:
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Increased Life Span
Until the nineteenth century most people didn’t age; they died. A hundred years ago few Americans reached age sixty-five; today thirty-five million of us have and we’re about to welcome the first wave of Baby Boomers who will become senior citizens. And more bad news for our nation’s retirement plans that pay a guaranteed lifetime monthly pension comes from the U.S. Census Bureau. Just after the end of World War II in 1950 only nine million people were age sixty-five and Social Security began paying retirement benefits to the few seniors who lived beyond age sixty-five. But, by 2000, the number had grown to thirty-one million. But the killer for pension plans is that according to the Census Bureau in just eighteen years, by 2030, the nation will double the number of people older than sixty-five. By then, seniors will outnumber school-age children in many states. For example, in 2000, twenty-four percent of Maine’s residents were younger than eighteen, and only fourteen percent were sixty-five and older. But by 2030 the numbers will flip: eighteen percent will be school age, and twenty-seven percent will be elderly.
As you read this book, please understand this country is getting older very fast. In 1980, 5,500 Americans turned sixty-five each day; in 2012, it’s estimated that it will grow to 10,000 each day.
But here’s the numbers that scare pension planners the most:
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In the future, the growth in the sixty-five and older population will be about three and a half times faster than the growth of the nation as a whole.
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On a more personal note, the longer you live the longer you can expect to live. Suppose you were born in 1940. At birth your life expectancy would have been seventy if a man, seventy-four if a woman. But many folks born in 1940 have died and those early deaths aren’t considered when calculating the life expectancy of those who remain. If you’re alive today, you can expect to live until around age eighty-two if you’re a man, and age eighty-four if you’re a woman. But the real shocker is the discovery in 2011 that twenty-five percent of current Social Security retirees will live to age ninety.
Here’s the problem: those born in 1940 have been collecting Social Security retirement benefits for six years. If they live out their life expectancy as figured in 2011, they can expect to collect monthly benefits for twenty years. And with the advances in medical care, the number could easily grow to twenty-five years. Just think when Social Security was established in 1935 the life expectancy was sixty-three years with benefits to start at age sixty-five.
But the scary numbers that face anyone managing a company pension or trying to save Social Security today is the startling jump in people ninety or older. According to the U.S. census bureau figures, the number of ninety-plus retirees will increase to about nine million by mid-century. A century ago, fewer than 100,000 people reached ninety.
This news is followed by the growing number of retirees living beyond age one hundred. There are six times as many centenarians as there were in 1980, from 15,000 then to over 100,000 in 2010.
These numbers come into perspective when you consider the first of the Baby Boomers turned age sixty-five in 2011. Born between 1946 and 1964, they number about seventy-seven million and start collecting checks from Social Security – one every eight seconds – about 2.8 million in 2011, rising to 4.2 million a year by 2030, and on average they will live well into their eighties with a growing number into their nineties.
The burden of fewer working American paying benefits to a growing number of retirees comes into focus when you consider the recent study from the Center for Medicare and Medicaid Services:
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Those over sixty-five and covered by Medicare is projected to soar from forty-seven million in 2012 to eighty million in 2030.
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If your calendar is not handy, that my friend is only eighteen years until the entire Medicare program for seniors’ hits a stone wall.
As a result, it’s easy to see why Social Security’s pay-as-you-go system of collecting taxes from a shrinking pool of younger workers to pay benefits to a growing number of older retirees will run out of money well before the number of age sixty-five and over individuals’ doubles by 2030.
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Rising Salaries To Meet The Cost Of Living
The second factor in retirement plans offering a fixed monthly income for life is the size of the monthly check at retirement. The larger the retiree’s check the more money the retirement plans has to save each year the worker stays on the job. And inflation has pushed up our salary on a yearly basis to a point where in 1980 median household income in 2008 dollars was just $20,447. But just twenty-eight years later the figure had risen to $30,744, according to the Congressional Research Service.
Now consider the poor pension plan. In just those few years the plan has to come up with fifty percent more money than it originally expected to pay out. But by 2018 the household income could easily top $40,000, twice the amount the plan had anticipated it would need to provide retirement checks.
As a result, private and public pension plans felt the under-funding first when they were unable to continue to pay the ever increasing annual contributions to pay for the ever increasing monthly retirement checks.
A look at the Social Security payroll tax also gives us a good idea of the rise in wages over the years and why defined pension plans haven’t been able to catch up to ever rising retirement checks. Take an individual starting work at age twenty-five in 1970. At that time, the first $7,800 of wages was taxed. But when he retired in 2012 the first $110,100 of wages was taxed.
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Decreased Contributions
Another problem is the older generation is rapidly moving toward collecting benefits while at the same time the younger generation is providing fewer workers to pay into the plans. As a result, every year private and public pension plans have failed to fund the amount of money required to pay out the already promised increased benefits. And, by the start of this decade, public pension plans began to report massive under-funding as retirement checks doubled and tripled while contributions from workers remained flat or declined.
Over time this country has suffered through financial crisis and a severe recession which has significantly reduced contributions to retirement plans. It’s also raised questions of just how much money is missing from the plans. A pension planner told me “the real concern right now is how much more will it take to support retirees than people assumed it would just five years ago.”
Finally, the cold hard reality is that the few employer-paid pension plans that remain in operation are, like Social Security, paying retirement checks to retirees with money set aside for those yet to retire. This is a death spiral that will terminate all remaining pension plans within the next few years.
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Fewer Workers To Support Retirees
Ever-higher salaries are not the only problem. An even greater problem is the changing population mix. At the same time, the country is facing an old-age population explosion; the number of young workers joining retirement plans is shrinking.
Here’s what’s been happening:
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• In the 1950s, eighty percent of adults were married. Today, maybe forty-five percent.
• People are delaying marriage, with the median age for the first marriage rising by four to five years.
• Divorce rates have more than doubled since the 1960s, reducing the average number of children from the marriage.
• In 1960, the average age at first marriage was just over twenty for women, twenty-three for men. Today, its twenty-six for women and twenty-eight for men.
• Women are delaying giving birth for the first time. In 1970, only four percent gave birth at age thirty or older. By 2007, the number had risen to twenty-two percent.
• One-third of men and nearly one-quarter of women between the ages of thirty and thirty-four have never been married according to the U.S. Census Bureau. This is nearly four times the rate in 1970.
• But the number retirement planners keep their eyes on are the percentage of women today without children. For ages thirty to thirty-four, 15.6 percent in 1976, 26.8 percent in 2008.
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What these numbers tell us is by the start of this century the older population, in combination with the falling birthrate and the delayed bliss for an increasing number of Americans has pushed the burden of paying for each retired person squarely on the pocketbooks of fewer workers. From something like a forty-to-one ratio when Social Security was created in 1935, to an eight-to-one ratio as recently as 1970 to less than three active workers today [that number will fall over the next decade to only two employees per retiree] who finance the benefits for each retiree. With so few workers paying in this could require either a fifty percent rise in the Social Security tax rate to maintain the current benefits, a one-third cut in projected benefits to maintain the existing tax rate, or reduced retirement checks from the System.
The lack of young workers paying into retirement plans has already occurred with many large corporations counting more retired employees drawing monthly retirement checks than active workers taking home paychecks. Worse yet, the American Institutes for Research estimated that, assuming the national birth rate continues at its current pace, America's population teeter-totter could flip-flop. By 2012, there will be fifteen million fewer people under the age of twenty, and the number over sixty-five will grow by fourteen million.
Already millions of Baby Boomers have begun signing up for Social Security at age sixty-two. If they chose early retirement – and millions already have – the number of seniors seeking benefits will rise by about three percent while the number of workers paying taxes rises by less than one percent.
The big question is:
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Will Means Testing Save Our Retirement?
With employer pensions fast disappearing and individual savings as percentage of income is at an all-time low the question being asked today is: can means testing save our retirement system?
Congress apparently thinks so. Faced with a Social Security program set to run out of money, many believe the only choice is to allocate available money to retirees based on a means test based on their taxable income.
Back in the Thirties, when most people still believed in the traditional American and Victorian ethos of hard work and self-reliance, going on the dole as it was called then, had a serious stigma. What’s more, people going on relief had to demonstrate they lacked sufficient means on their own, hence the term means test.
As President Roosevelt knew in 1935 one of the keys to the passage of Social Security was reassuring Americans that retirement benefits was insurance paid for with their payroll taxes and received as an earned right, not handouts or charity.
Shortly after Social Security became law, Secretary of Labor Frances Perkins wrote in the New York Times Magazine, “Benefits will not be granted as a matter of charity but will be earned annuities to which the recipients are entitled as a matter of right.”
Now that retirees have no right to collect the benefits, means testing will face each person applying for Social Security benefits.
Means testing sets an income level (or several levels in a banded system) below and above which government benefits may be taxed, reduced or denied. But the economic effects of means testing are much the same as a tax increase on higher income retirees. It’s only semantics if the $10 is called a “tax” or a “premium,” or “means testing.”
For example, for every $1,000 of taxable income beyond the threshold, you might have to pay more for your Medicare premiums, have your Social Security retirement benefits subject to income taxes and have your Social Security retirement check reduced or eliminated.
I’m not talking about something in the future. Today you already face means testing on when your Social Security monthly benefit is taxed and congress has already slapped means testing on monthly premiums for Medicare Part B. In each case you’ll get the same benefits; you’ll just pay more depending on your taxable income under means testing.
But the next big hammer to fall is means testing your right to receive a monthly retirement check. The idea of linking Social Security retirement benefits to taxable income in retirement has been filtering out of congressional committee hearing rooms for the past twenty years. It was again included in President Bush’s plan to offer private Social Security Accounts, and the center piece in the 2010 budget reduction proposals submitted to President Obama. The reason for means testing benefits is obvious; the System saves huge amounts of money by reducing or eliminating the retirement checks on the basis of reported annual income for those the means testing schedule determines don’t need the money. The names that often come to mind most is Microsoft founder Bill Gates and investor Warren Buffett. Everyone knows they don’t need the money. But, for the rest of us, when does our taxable income in retirement hike our taxes, premiums and reduce our retirement benefits?
Now, it gets tricky. What is the test that can reduce or eliminate benefits? Will this include income and assets? How could the test be applied?
Here are some ways under consideration today:
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• All taxable income earned on the job.
• “Wealth related” income, such as investment income or income from a business called “affluence testing.”
• Eliminate benefits for those exceeding the threshold, or phase out benefits gradually as income or assets increase beyond the threshold.
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But the justification of denying or eliminating benefits to workers who have paid taxes into the system during their working life is questionable. For example, we do not deny interest payments on U.S. Treasury bonds to wealthy owners regardless of their reportable income.
But the real problem of means testing income for retirement checks is we send the wrong message. One worker, who was never able to save because he or she spent all their money on an expensive lifestyle, gets the Social Security retirement check. The other, a diligent saver most of his or her life and retired with a good net worth and taxable income, is denied the check.
This is a classic case of wealth transfer. On the one hand, an individual pays taxes based on a higher income in retirement but receives no benefits, while the other pays few taxes and receives a full benefit check. But the sinister thing about this wealth transfer program is that the thresholds of taxable income in retirement that determines the size of your retirement check can change anytime. And you can bet on one thing: as Social Security continues to bleed cash more people with lower taxable incomes in retirement will begin to lose part of their monthly retirement check.
But you’ve got to give Social Security credit. Means testing for a retirement check saves the System a huge amount of money. And for a program set to run out of money in a few years this is a change many believe is waiting to happen.
Please understand as the years unfold more means tests will be put in place to conserve cash, raise taxes and withhold benefits. All these new plans will continue to be based on your annual reported taxable income in retirement.
As you read this book, it’s my hope you’ll understand how important it will become to avoid stashing cash in places like IRAs, 401(k)s and pensions where you have to pay taxes and face means testing before you can use the money in retirement.
Once upon a time, in a city somewhere in America lived a hard-working employee who used his experience and felt comfortable solving his daily problems at work. But he felt the money he was pouring into his retirement plan was moving further from his grasps in retirement. To use his retirement nest egg he’d have to pay ever increasing taxes based on his retirement income and even lose part of all of his expected Social Security retirement check.
He began to understand if he wanted to build a realistic retirement nest egg he would have to take responsibility for his own actions and make sure once retired he could take out the money in such a way that most of it would end up in his pocket. In short, he could no longer wait for good things to happen. Even if his retirement date was years in the future it was time to trust his ability to solve his own retirement income problems.
What had taken him so long to come to this conclusion was he knew he’d have to divert some of his money he would normally have plowed into his IRA and 401(k) to pay income taxes on his past contributions. And he’d have to spend time to remain constantly alert to recognize the best way to hold his money. It was time; he continued to tell himself, he didn’t have. But it had now become apparent he had to find the time if he wanted to retire with enough money after taxes and means testing to pay his bills, play golf and plan the vacations he’d always wanted. That’s because, as we’ll discover later, knowing how to hold your money over the years will become the most important task you’ll have if you are to realize a realistic retirement dream.
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In simple English, the key to retiring on easy street will be your ability to avoid dumping your retirement savings into a 401(k), 403(b) and IRA.
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The next problem he’ll face is that it will take a lot more money in retirement than he had once planned for. That’s because for most people retirement is no longer age sixty-five with company-paid pensions and Social Security. Suddenly seventy – or even seventy-five – is the new age sixty-five. Congress is telling us with proposals for collecting “normal” Social Security benefits at age sixty-nine or seventy. And, as more people work longer or opt for second careers to help fund their later years, the face of retirement is changing.
As a result, about now panic hits the fan when he realizes all those years he should have been saving a few dollars each week instead of maxing out on his credit card.
Here are the grim facts:
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• Half of all employees in the private sector have no retirement plan at work, or haven’t joined one.
• Of those covered by a company plan most employers require at least a contribution of three percent of pay to earn a match and most employees fail to meet that requirement.
• Only a few workers in the private sector still have a traditional employer-paid pension to save them if their 401(k)s crash.
• Only thirty percent of Americans count on income from their own savings and investments in retirement, the first time this figure was below forty percent in thirty years.
• Only two-thirds of working Americans say they or their spouse has saved money for retirement. Of those who have saved only forty-nine percent report having saved less than $25,000 in retirement plans and investments. Even among workers over age fifty-five and soon to face retirement, almost a third has saved less than $25,000 in a retirement plan.
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Now you may understand why, according to Social Security, one-third of the workforce have no savings set-aside specifically for retirement, and once retired two-thirds of all elderly retirees depend on Social Security for all or the principal source of their income.