Something else it includes that I haven’t paid much attention to until now is an illustration of a sturdy three-legged stool. This stool represents what the state of Texas sees as the three legs of any healthy retirement plan: Social Security benefits, a 401(K), and our pension. Recently, I have begun to wonder about the sturdiness of this three-legged stool.

I have heard of many bankruptcies by both companies as well as governments over the last two years. Also, the last time I checked my statement I noticed an asterisk beside the health plan benefits. The asterisk stated that the health plan was not a guarantee and that basically the state has discrepancy to do away with health insurance benefits in retirement should it see fit. This had me thinking, for those of us who are fortunate enough to be offered pension plans (only 31% of employees were offered a pension plan in 2010), how safe is our pension should our company or agency declare bankruptcy between now and when we are ready to retire?

Your Private Sector Pension has Insurance

Pension plans may run out of money, the company may liquidate and there is no new company to take the plan over, or perhaps the current company can continue to operate but not while maintaining its pension plan. All of these scenarios spell trouble for workers who are counting on their pension benefit. Fortunately, there is insurance for your pension. The Pension Benefit Guaranty Corporation (PBGC) was formed in 1974 to insure private sector pension plans from the scenarios listed above.

This insurance is not funded by taxpayer money. Instead, companies must pay insurance premiums set by Congress. Other funds are received from investment income, assets from pension plans taken over by PBGC, and recoveries from the companies formerly responsible for the plans. To give you an idea of how much is collected, in FY 2011, $2.4 billion was collected from single-employer and multiemployer programs, and as of September 30, 2011, the PBGC had an investment portfolio worth almost $70 billion.

PBGC Limits Types of Benefits and Amounts

The PBGC has its limits including the type of payout and the amount of payout. For example, the PBGC does not guarantee health or welfare benefits, life insurance, vacation pay, severance pay, or benefits payable because of disability that occurs after the guarantees take effect.

Maximum Pension Benefit. Also, the maximum benefit payout for a life annuity with no survivor benefits for 2011 is:

• $54,000 yearly ($4,500 monthly) at age 65
• $42,660 yearly ($3,555 monthly) at age 62
• $24,300 yearly ($2,025 monthly) at age 55

Notable Bankruptcies and Pension Failures

Since its inception, the insurance plan has funded pensions for 1.3 million workers and retirees in 4,140 terminated single-employer plans. Generally air transportation and the metals industry account for 50% or more of all pension failures. However, with the decline in the auto industry and multiple automaker bankruptcies during the recession, automotive parts manufacturer Delphi Corp. became the second largest pension failure in the PBGC’s history in July 2009 with 69,402 vested employees.  The liability assumed by the PBGC was a staggering $6.1 billion. Other notable bankruptcies that resulted in failed pension plans includes United Airlines with pension liabilities of $7.4 billion (2005), Bethlehem Steel with pension liabilities of $3.7 billion (2003), and US Airways with pension liabilities of $2.8 billion (2003).  In recent news, PBGC is currently protecting the pension plans of 63,000 former Kodak employees as Kodak files for Chapter 11 bankruptcy.

Currently (as of the end of 2008), the PBGC is underfunded by a staggering $10.7 billion, a figure that continues to grow. This is due to the high number of company bankruptcies over the last three years.

So what does this mean for me and my public-sector pension plan? It turns out that if the state of Texas declares bankruptcy at some point between now and 30 years when I will be hoping to retire, my pension will not be insured by the PBGC (only private sector pension plans are insured). However, most public sector pension plans are protected by state laws and constitutional amendments. As for Texas, it looks like I will be fine.

Do you have a pension? Is it a private sector or a public sector plan? 

Other Articles You May Enjoy

• 5 Weird Bankruptcies Declared During the Recession
• Company is Going Bankrupt. What About My Pension?
• Brand Names that Kicked the Bucket During the Recession

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Many of the limits that are going up for 2012 are based on the increase in the cost of living (COLA) index. However, even though the index went up, some of the limits weren’t adjusted. Here’s a rundown on what will change and what is staying the same.

2012 Retirement Account Limits

Now you can plan your 2012 contributions to all of your retirement accounts:

• 2012 401k Limits: The 2012 limits for 401k plans (both Roth and traditional) will go up from $16,500 to $17,000. This limit also applies to 403b plans and 457 plans for 2012. In order to take advantage of the increase, you’ll need to change your election with your employer to a higher deduction amount.
• 2012 IRA Limits: The 2012 limits for IRAs (Roth and traditional) will remain unchanged at $5,000. And while your IRA contributions probably don’t come out of your paycheck, I think it’s still important enough to make the list!
• 2012 Catch-Up Contributions: 2012 Catch up contributions for both IRAs and 401ks will remain the same as last year – $1,000 for IRAs, and $5,500 for 401ks. If you’ve hit your 50s (or over), be sure to take advantage of the higher limits.
• 2012 SEP-IRA Limits: The 2012 SEP IRA limits will go up from $49,000 to $50,000 (as long as you don’t exceed 25% of compensation). Just make sure you review the calculation carefully, as the 25% is based on net profit, not gross revenues.
• 2012 SIMPLE IRAs: The 2012 limits for SIMPLE IRAs remain unchanged at $11,500, as does the SIMPLE catch up contribution at $2,500.

2012 Health Benefit Plan Limits

If you are working on your open enrollment paperwork this week, be sure to review the 2012 limits for the following health plans changes:

• 2012 Health Savings Account Limits: Individual HSA contributions will increase from $3,050 in 2011 to $3,100 in 2012. Family HSA limits will increase from $6,150 in 2011 to $6,250 in 2012.
• 2012 High Deductible Health Plan Limits: Maximum out of pocket spending limits for 2012 will increase to $6,050 for single and $12,100 for family. The minimum HDHP deductibles remain the same at $1,200 for single and $2,400 for family.
• 2012 Flexible Spending Account Limits: As we previously mentioned 2012 will be the same as last year with no federal FSA limits (your employer can still designate a limit). There will be a $2,500 maximum per employee in 2013.

2012 Social Security Limits

Social Security is going up, both for people paying in, and people taking money out:

• 2012 Social Security Wage Base Limits: The 2012 Social Security wage base is going up for the first time in a few years. The wage base in 2012 is $110,100. It’s an increase over the 2011 Social Security wage base, which was $106,800. What it means is that you’ll pay additional Social Security taxes in 2012 on the extra $3,300 in wages.
• 2012 Social Security Benefits: Social Security benefits will increase 3.6%. There hasn’t been a benefit increase since 2009. Good news if you’re currently receiving social security benefits.
• 2012 Social Security Payroll Tax Limits: We still don’t know if the 2% Payroll Tax Cut we have this year will be extended into 2012. Once we know that, we’ll be able to more accurately calculate the amount of Social Security tax taken out of your paycheck.

Based on the new 2012 limits above, you should be able to calculate most of what your paycheck will look like in the new year.

Which limit change are you the most excited about?

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There’s a lot of advice floating around to access your taxable accounts first, then your tax deferred accounts, and finally your Roth IRA. But in reality, it can be better to focus on optimizing withdrawals and Roth conversions to minimize taxes. That’s where the ORP comes in handy.

Optimal Retirement Planner

The planner doesn’t just calculate a final number like many other retirement calculators, it helps you plan how to access your retirement accounts in the best way possible broken down by year:

The Optimal Retirement Planner (ORP) is a retirement decision support system (RDSS) that optimally schedules retirement savings and withdrawals to maximize the amount of after-tax money available for spending throughout retirement.

ORP Inputs and Outputs

Inputs: Run the ORP with your typical retirement planner information (ages, account balances, pension income, social security benefits, annual retirement savings, age to retire) and other financial based questions. The input screen is quick to run through, if you have all of your information at your fingertips.

Outputs: The outputs are where I think the ORP is a unique retirement planner. Here’s a list of the output schedules by year:

• Contributions to retirement savings accounts
• Annual after-tax income
• Withdrawals from retirement savings accounts
• IRA to Roth IRA rollovers
• IRA to After-tax Account transfers
• Annual personal income tax bracket
• Annual retirement account balances.

ORP Review

I really like the ORP to get a good sense of planning each year of withdrawals like an overall roadmap. I’ve run some scenarios that suggest high Roth conversions in early years. This makes sense based on minimizing taxes over a lifetime, but obviously, you still need to make decisions about what to do with the data.

In addition, you really need to read through the explanations of the report to understand not only the outputs, but what the model does and doesn’t do.

The ORP allows you to save your input parameters using cookies, but unless I’m missing something, there isn’t a good way to save all your information to revisit in the future, so I’d recommend dumping the data in excel when you’re done.

Tax Limitations

Much of the ORP strategy is based on maximizing the lower tax brackets in the current tax environment. Obviously, one of the drawbacks (like with most retirement calculators) is that the tax brackets can, and likely will, change over time. Since the calculator doesn’t have a way to account for this, you also need to add a layer of common sense to the outputs and understand exactly what it’s suggesting and why.

Action Plan

If you haven’t given the Optimal Retirement Planner a try yet, it’s one of the retirement calculators that you might want to run your numbers through to see what it says. I’d be interested to hear what kind of strategy it recommends for drawing down your nest egg.

Have you used the Optimal Retirement Planner? What are your thoughts?

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No More Statements in the Mail

If you do not know where your last Social Security statement is, you can use the retirement estimator provided by the Social Security Administration to follow along. In addition, since the SSA is no longer mailing the benefits statements, you’ll have to use the estimator going forward to track the details below.

What is Your Estimated Benefits Statement?

This is an annual statement from the Social Security Administration that details what you have paid into the Social Security and Medicare programs throughout your working career, what your taxed Social Security and Medicare earnings were for every year that you paid into these systems, and an estimate of your Social Security benefits. You will receive this automatically if you are 25 years of age or older, you are working, and you do not currently receive benefits. The estimate includes a breakdown for retirement (you must have earned a total of 40 credits of work in order to qualify for retirement benefits; your credits will be disclosed in this statement), disability, family, survivors, and Medicare.

Windfall Elimination Provision (WEP)

I work for the state government and have one of those rare breeds of retirement plans: the pension. I will be vested after 5 years, and am currently about to start my 3^rd year of service. While reviewing my last Social Security Statement, I noticed a paragraph talking about this provision. This provision applies to people who work in jobs where social security taxes are not paid on their pension plan, and they have enough work credits to qualify for social security income. The reason for this reduction is because a worker in this situation would benefit above others by getting both a pension and a social security income even though social security taxes were not paid on the pension income. According to my SS Statement, the maximum monthly reduction in 2010 was $381. It should be noted that if you receive a small pension, than it will likely not reduce your social security benefits.

Government Pension Offset (GPO)

Since I have a pension (though not vested in it yet) this regulation could apply to my spouse. If this applies to him as my spouse (also applies to widows/widowers), his Social Security benefits will be reduced by two-thirds of our government pension whether he takes it in one lump sum or in monthly payments.

Social Security Benefits are Running Out

There is so much speculation about the state of our Social Security system, particularly for those in their 40s and younger. Even though it appears that we will be continuing to pay into the system, we are fearful (and rightfully so) that we will not be able to get any benefits out of it. Then there is the other camp of thought that states so long as we collect benefits from taxpayers there will always be benefits to pay out to people.

How about we stop speculating and look at the source for some answers: our Social Security Benefit Statements. On the cover letter, the SSA states:

…The Social Security Board of Trustees now estimates that based on current law, in 2037, the Trust Funds will be depleted. Because people are living longer and the birth rate is low, the ratio of workers to beneficiaries is failing. Therefore, the taxes that are paid by workers will not be enough to pay the full benefit amounts scheduled.

So by how much will the SSA be short by? Apparently there is enough in the trust fund to cover 76% of their obligations in the year 2037.

The SSA goes on to give us guidance on what we should do. They state that:

Financial planners generally agree retirees will need about 70-80 percent of preretirement earnings to enjoy a comfortable retirement. For an average worker, Social Security replaces about 40 percent of annual preretirement earnings.

So there you have it, from the horse’s mouth: you will likely receive only partial benefits if you are 40 or younger, and you should be saving enough in your own retirement accounts to cover 30-40% of preretirement income because even at full benefits Social Security income will only replace 40% of it.

Will you be receiving a pension? Assuming you receive Social Security benefits, will they be reduced because of your pension?

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In 2010, income limits for Roth IRA conversions went away, and thousands of people converted traditional IRAs to Roth IRAs, paying income taxes on investment gains. The rationale for this was that the account holder could pay taxes on gains to-date, but would never have to pay taxes on any additional gains.

For most people, conversion was a great way to avoid long-term tax liability. But in some cases, the conversion may no longer be the best move. You might decide to permanently reverse your conversion, or reverse your conversion and re-convert at a later date (at least 30 days after completing the reversal).

Why to Reverse your Conversion

There are many reasons to reverse your conversion. Some include:

• Your account lost money since conversion, so you paid taxes on gains that no longer exist – you can reverse, then re-convert and owe less money.
• You are or expect to be in a lower tax bracket than last year – as above, you can reverse and reconvert, owing less money.
• You paid taxes on gains using money that you need for an unexpected expense – you can reverse and get back any tax that you paid in

How to Reverse your Conversion

To “reverse” your conversion, you actually need to recharacterize your Roth IRA to an IRA. You must do so on your tax return for the year in which you initially converted, meaning your ability to reverse your conversion is time-limited. To complete the recharacterization, follow these steps:

1. Decide if you are ready to reverse your conversion now, or if you need more time to decide
2. If you need more time to decide, file a tax extension, which will permit you to file your returns as late as October 17 (although you still owe tax payments by the April 18 deadline). Alternatively, you can file in April and submit an amended return by October 17.
3. Notify the financial institution that maintains your Roth IRA of your desire to recharacterize. They should be able to walk you through gathering the required information, which should include the date and amount of the initial conversion.
4. Report your reversal on your tax returns (Form 8606) for the year in which the conversion took place.

Note that you can also recharacterize IRA contributions made last year as Roth IRA contributions, or vice-versa. We previously wrote about reasons for doing this and the recharacterization process, which is identical to the one outlined above.

For an in-depth discussion of conversion and recharacterization strategies, see “Roth IRA Conversions – An Agressive Strategy”

More on Roth Conversions and Taxes

• When Should You Pay Taxes on Your 2010 Roth Conversion?
• Roth Conversion Strategy to Minimize Taxes
• How to Track Your Roth IRA Contributions… and Why You Need To!
• Unconventional Roth IRA Strategy to Lower Tax Bill

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Increases in the 401k limits and IRA limits are determined based on inflation, so in addition to the 401k limits going up, the social security adjustments will also go up. However, there were no increases for the IRA retirement contribution limits.

These are the limits for the traditional IRA and the 401k, although the Roth 401ks and IRA limits will be the same as the traditional 401k and traditional IRAs.

2011 & 2012 Contributions

Here are the 2011 & 2012 contribution limits for IRAs and 401ks:

You can make your 2012 contributions as early as January 2 for the whole year. If you contribute 2012 IRA money between January 2 and April 15, be sure to designate calendar year 2012 if you have already contributed the maximum for 2011.

To maximize your IRA investments, make sure you aren’t paying extra fees in your IRA. You can transfer your IRA to Scottrade to avoid annual fees.

2011 Contributions

You can still make 2011 contributions before the end of the year for your 401k. 2011 IRA contributions can be made until April 15, 2012.

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What is a Tax Wage Base?

Social security taxes, (or OASDI taxes) are the taxes that are taken from your paycheck to contribute to the social security program. However, there is a wage base limit, and earnings above this amount are not taxed.

The social security tax wage bases are per person, and are not impacted by a husband and wife who meet the wage base when adding their incomes together.

What Happens When You Reach the Social Security Limit?

Any earnings over the tax wage base are not subject to social security taxes. Reaching the taxable wage base allows you to take home more of your money in your paycheck and save on taxes.

In fact, I once had a professor in college, who used the social security wage base as an earnings goal each year, because once you earned money over the limit, it was like getting an automatic raise.

However, it’s also important to understand that those same limits will apply when you qualify for Social Security and your benefits are computed.

Social Security Tax Rate

The current social security tax rate is 6.2% of your earnings (or 12.4% for self employed), and unlike saving on income taxes, you can’t deduct retirement contributions to save on your social security taxes.

Update: The 2011 Payroll Tax Cut temporarily lowered the social security tax rate for the employee to 4.2% in 2011. The employer will still need to pay 6.2%. It is still uncertain if there will be a 2012 Payroll Tax Cut Extension.

The social security tax rate is separate from medicare taxes, currently at 1.45% (or 2.9% for self employed), which has no wage base limit, and will increase to 2.35% due to the new Health Care Reform Bill for high earners.

Wage Base History

Here are the social security taxable wage base limits for the last six years:

• Wage base 2007: $97,500
• Wage base 2008: $102,000
• Wage base 2009: $106,800
• Wage base 2010: $106,800
• Wage base 2011: $106,800
• Wage base 2012: $110,100

More on Social Security

No COLA Adjustments. The Social Security Administration, who made the wage base 2012 announcement also announced that people receiving social security benefits will get a cost of living adjustment (or COLA) adjustment in 2012. Social security benefits will go up 3.6%. They did not increase in 2011.

Not Just Retirement. Social security isn’t just for retirement. In fact, the entire acronym for OASDI tax is Social Security’s Old-Age, Survivors, and Disability Insurance.

Social Security Statements. Be sure to review your social security statement every year and make sure the earnings amounts are correct. Otherwise, An Administrative Error Could Cost You Your Retirement.

Social Security Taxes. If half of your social security benefits plus your other gross income is more than $25,000, you may have to pay income taxes on social security benefits.

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The 401k limits and IRA limits are determined based on inflation, and while there increases in the 2012 social security wage base and 2012 Roth 401k limits, there were no increases for any IRA limits.

I highlight the Roth IRA and the Roth 401k because they are my favorite retirement plans; although the limits for traditional 401ks and IRAs are the same as the Roth 401k and Roth IRAs.

2011 & 2012 Contributions

Here are the official contribution limits from the IRS:

You can make your 2012 contributions as early as January 2 for the whole year. If you contribute 2012 Roth IRA money between January 2 and April 15, be sure to designate calendar year 2012 if you have already contributed the maximum for 2011.

To maximize your IRA investments, make sure you aren’t paying extra fees in your IRA. You can transfer your IRA to Scottrade to avoid annual fees.

2011 Contributions

The deadline for 2011 IRA contributions is April 15, 2012.

More Helpful Roth Topics

• To Roth 401k or Not to Roth 401k?
• Can You Have a Roth 401k and a Roth IRA at the Same Time?
• How to Make Early Roth IRA Withdrawals
• How to Track Your Roth IRA Contributions… and Why You Need To!

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What is a Roth 401k?

For those of you haven’t heard of a Roth 401k, Madison has done a great job summarizing what they are and how they work.

Here are the 2010 Contribution Limits.

What does this mean to you?

Here are a few things to keep in mind when considering whether or not to invest in a Roth 401k:

1. What do you think your marginal tax rate will be in retirement?

   How much in the way of taxes you think you will be required to pay on the marginal dollar when you are retired. If the marginal tax rate at retirement is the same as it is now, traditional and Roth 401k’s are equivalent. However if you think your marginal tax rate will be higher in retirement than you are paying now, you might be better off with a Roth 401k.

   But there are some considerations you should keep in mind. What you think your tax rate will be at retirement applies only to the marginal dollar, which is the last dollar you can invest between traditional and Roth 401k. It is not the case with the entire contribution (or average dollar, rather than marginal dollar).

   Marginal taxation means that income is taxed at increasing rates as it goes higher. Even if you think the marginal tax rate in the future will be higher, there will still be lower brackets and these lower brackets should be filled with money from a traditional 401k first. If it is filled with money from a Roth 401k, you will actually end up being worse off.

   Confused? Take the below example (A married couple earning $120,000 between the two of them if they file jointly using standard deductions, and 6% total 401k withholding):

   

   Because the way the traditional 401k works, the dollars this couple contribute are “taken off the top”, in their income’s highest tax bracket. After they retire, the dollars they withdraw from their traditional 401k fill in from the bottom tax bracket first.

   Even if their marginal tax bracket in retirement is higher due to tax increases, a large portion of the traditional 401k withdrawal may still be taxed at a lower rate than what it was when they contributed the money during their working years.

   Until you know you can generate enough income from your traditional 401k to fill the lower brackets, it doesn’t necessarily make sense to contribute to a Roth 401k. However, if you expect to have a large balance in a traditional 401k (or IRA) or a defined benefit pension plan, either of which (or combined) are large enough to fill your lower tax brackets in retirement, then contributing to Roth makes some sense.

2. Is your current income higher than the Roth IRA limit?

   The Roth 401k offers an advantage to high-income earners who are unable to contribute to a Roth IRA because of income restrictions. There is no such restriction for a Roth 401k. By getting around this income restriction and utilizing the ability to roll over a Roth 401k to a traditional Roth IRA, you could potentially utilize the Roth IRA’s inheritance advantages. Know that you can do a similar exercise to a traditional 401k as well (first by converting to an IRA then to a Roth IRA), although you will incur a tax liability when you roll that over into a Roth.

3. Where do you plan on living in retirement?

   Does the state you work in have a high income tax? Do you plan on living in the same state in retirement or do you plan on living elsewhere? What happens if you move from a start with high taxation during your working years to a state with a low level of taxation? Chances are, you’ll have no idea where you’ll end up living in retirement.

   However, if you end up moving to a low-tax state like Texas for your retirement, contributing to a Roth IRA would make no sense. By prepaying your tax liability by contributing to a Roth 401k, you would be forgoing a beneficial tax-free contribution in a high tax state, and you would not see the benefit if you happened to live in a low-tax state. You would end up paying more taxes over your life than if you had gone with a traditional 401k.

4. Do you take advantage of income-based tax write-offs and/or credits?

   By contributing to a traditional 401k, you are effectively telling the IRS that you make “less” than you otherwise would have. You appear less rich in the eyes of the government. On top of that, if you take advantage of tax incentives that are based on your level of income (such as the child tax credit, Roth IRA personal income limits personal exemptions, tuition credit, etc), you may find yourself making too much to be eligible in the future, even if your total salary hasn’t changed.

   If that happens, you may not only end up paying more tax up front (in the form of a Roth 401k prepayment), but you may also pay more taxes as a result of programs you are no longer eligible for. Your “increase” in taxable income may even trigger the AMT. Contributing to a traditional 401k will help you qualify for tax benefits and escape or reduce the impact of AMT.

Is a Roth 401k for you?

A Roth 401k is good for people in low paying jobs now but expect to have high paying jobs later, such as current college students or recent grads. Or for the tiny minority of people who are already at the highest marginal tax level and expect to be there indefinitely. But the marginal tax rate concern, and your unique lifetime earned income (and ability to save) could mean you don’t see much in the way of a tax benefit in retirement.

Ultimately, your unique financial situation should be looked at by a tax professional in order to determine which route you should go. And remember, this is your retirement. Only you can make the best decision for your retirement.

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It consists of many parts, including guaranteed income to the retired, disabled, and qualified survivors, insurance in the form of Medicare, unemployment benefits, and other programs. Today, we’ll specifically look at what it takes to qualify for retirement and disability benefits.

Social Security Work Requirements

Your ability to receive disability and/or retirement payments primarily depends on your work history. For you and your dependents/survivors to qualify for full benefits under each program, you need to be “fully insured.” You and/or your dependents may also qualify for limited benefits if you are “currently insured.”

Each status requires a certain number of social security quarters of employment earnings. This number changes from year to year. In 2010, a quarter of earnings is $1,120. You can earn up to 4 quarters per calendar year, regardless of when the earnings were actually earned – once you make $4,480 in a year, you have 4 quarters for that year, whether you earned that money in January or December. Current requirements are as follows:

• Fully Insured means that you have 40 quarters of qualified earnings after the age of 21.
• Currently Insured workers have at least six quarters of coverage out of the previous 13 calendar quarters.
• Disability Insured varies based on age. Those between 21 and 24 have to have 6 quarters of coverage in the last 12 quarters. If you are 24-30, you have to be covered for half of the available quarters after age 21. If you are over 31, you have to be fully insured (40 quarters of coverage) AND have earned 20 of those quarters in the last 40 calendar quarters.

Other Social Security Requirements

In addition to a certain number of quarters/years of work experience, you have to meet additional qualifications to actually claim and receive your benefits:

• Retirement: To claim your social security retirement benefits, you have to be fully insured and reach full retirement age, which varies from 65 (for those born before 1938) to 67 (for those born after 1960). You may receive reduced benefits before full retirement age or increased benefits if you defer receipt past retirement age. Your spouse and dependents may also claim benefits based on your work history.
• Survivor: When you die, your survivors (spouse and dependents) may be able to claim social security death benefits based on your retirement benefits. Amounts and eligibility will vary depending on whether you were fully or currently insured at death. This benefit applies regardless of your age at death.
• Disability: To receive social security disability benefits, which are notoriously hard to qualify for, you must meet the definition of disability insured above AND prove that you meet the government’s definition of disabled. Because this definition is so hard to meet, most people should carry supplemental disability insurance.

Social Security Benefits

If you have met all requirements, you will receive a percentage of your highest years of income, based on many very complicated calculations completed by the Social Security Administration. You can see an estimate of your benefits using the social security calculator. The system is calibrated so that lower-paid workers receive a higher percentage of their income than higher-paid workers.

As mentioned earlier, your spouse and dependents may also receive benefits based on your work history. Your Social Security Statement, received annually about 3 months before your birthday, will provide personalized details about your potential benefits.

Social Security Benefits Adjustments

Update: Social Security benefits are based on the cost of living (COLA) index. For 2012, Social Security benefits will increase by 3.6%. There has not been an increase since 2009.

The Future of Social Security

As we all know, Social Security will have to undergo major changes to stay solvent in the future. So while you should be aware of this information, you should also make sure you are using retirement accounts to plan for the future on your own!

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But to really supercharge your savings and make sure you are extra-prepared for retirement, you should also take advantage of catch up contributions. Catch-up contributions are special provisions that allow you to contribute additional funds to your retirement accounts as you get closer to retirement. This has the double benefit of helping beef up your retirement savings while deferring taxes.

Why Catch Up Contributions Matter

Someone maxing out a 401k with an 8% earnings rate would save just over $500,000 between ages 50 and 65. Someone taking full advantage of catch-up contributions would save over $667,000 in that same time period:

If you withdraw 4% of your nest egg annually in retirement, that additional savings would mean an additional $6,000 of income per year.

Over 50 Catch up Contribution Limits

Most retirement accounts allow for additional contributions for account holders over 50:

• 401(k), 403(b), 457: May contribute $5,500 above the limit of $16,500 ($17,000 in 2012), for a total of $22,000 ($22,500 in 2012). Remember that the 401k catch up limit applies to the total of all 401k and 403b accounts held by one employee, even across multiple employers. 457 accounts have a separate $22,000 limit.
• Traditional IRA/Roth IRA: Up to $1,000 above the standard $5,000 maximum Roth contribution.
• SIMPLE IRA: Up to $2,500 above the standard $11,500.

403b 15-year Catch-up

If you have 15 years of service with a public school system, hospital, home health service agency, church, or certain other organizations, you can increase your 403(b) contributions by the lesser of:

• $3,000
• $15,000 reduced by previous catch-up contributions under this rule
• $5,000 times the number of years of service minus total contributions made in earlier years

The IRS explains further. Note that this applies to all employees with 15 years of service at a qualified organization, regardless of age. If you are over 50 you may take this AND the over-50 catch-up noted above.

457 Double Limit Catch-up Contribution

In the three years before normal retirement age (as defined in plan document), government and certain non-government employees may take what’s known as the “double limit catch-up.” If you did not contribute the maximum possible amount in previous years, you can contribute the lesser of double the current year’s maximum amount ($16,500) OR the sum of “missed” contributions in previous years. For example:

• If you have $10,000 of unused contributions, you can take an additional $10,000 in any one of the three years before retirement.
• If you have $30,000 of unused contributions, you can take an additional $10,000 in each of the three years before retirement.
• If you have $100,000 of unused contributions, you can double maximum contributions for three years before retirement, but won’t ever be able to make up that $100,000 completely.

If you always maxed out your contributions, this rule does not apply to you. If you take this catch-up you cannot take the over-50 catch-up for 457s.

Note that current tax and catch-up rules allow you to contribute up to $25,000 to a $403b and $33,000 to a 457 in one year – not to mention another $6,000 to an IRA!

Take Action

If you want to increase your retirement savings, log in to your online account or contact your benefits coordinator at work.

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If you’re considering a traditional IRA conversion to Roth IRA this year, here’s a guide of Roth conversion articles to help you navigate conversion rules and the pros and cons of Roth IRA conversions.

Roth IRA Conversion Rules

2010 Roth Conversion Rules. Roth conversion rules and guidance about Roth conversions in 2010.

Tax treatment of Roth Conversions. Pro rata distribution rules for the Roth IRA and the 60 day rule for Roth conversions.

How to Make a Roth IRA Conversion. Once you decide if you want to make a Roth IRA conversion, here’s how to do it!

Roth IRA Conversion Strategies

Roth Conversion Strategy to Minimize Tax. Minimize the taxes on your conversions by implementing a multiple conversion strategy.

Roth Conversion Strategies. How to increase your basis in your IRA and avoid some of the taxes with Roth conversions.

Pros and Cons of Roth Conversions

Roth IRA Conversion Considerations. Pros and cons of Roth conversions and things to consider before you make a Roth conversion.

Roth IRA Conversion Calculators. A list of Roth conversion calculators to help you with your analysis.

Roth IRA Extras

Roth IRA for Kids. Want to help your kids save for the future tax free? An excellent opportunity is a Roth IRA for kids.

2010 Roth IRA Limits. In addition to your Roth IRA conversion, you can still make a regular Roth IRA contribution if you meet the income limits. Beware though, a large Roth conversion could make you ineligible to make a contribution if you elect to include the income in the current year.

Roth IRA penalty free withdrawals. Once you make your Roth conversion, you can withdraw your money tax free and penalty free after five years.

Worksheet to track Roth IRA contributions and conversions. You’re in charge of tracking your own contributions and conversions for tax purposes. Make sure you do so!

Phew! Everything you need to know about Roth IRA conversions!

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We previously explored roth conversion strategies like increasing your basis to avoid taxes, but if you’re ready to convert the taxable portion of your traditional IRA, this one might be for you!

Roth IRA Conversion Strategy

Here’s the plan to execute the Roth IRA conversion strategy:

Create multiple traditional IRAs. For example, if you have a $100,000 traditional IRA to convert, separate it into 4 $25,000 traditional IRAs.

Convert each IRA. For each account, make a traditional IRA conversion to a Roth IRA. You’ll want to keep each new Roth IRA separate.

Invest differently. In your new Roth IRAs, you’ll want to take a separate investment approach. Separating by each asset class would probably make the most sense and gives the most flexibility.

Monitor Returns. Since each Roth IRA holds a different asset class, the returns will vary. If the value goes up, leave it alone.

Recharacterize. Select the accounts where the value went down, which could be all, some, or none, of the new Roth IRAs. Reverse the conversions with a recharacterization by October 15, 2011 (with an extension), for 2010 Roth IRA conversions.

Tax Savings. With this strategy you’ll avoid paying taxes on money you lost, without having to recharacterize the entire conversion, allowing you to keep the conversions on the winners!

Tips and Tricks

Reconvert. You can later reconvert the money that you recharacterized, but there is a waiting period of at least 30 days and at least until the next year. You’ll be able to reconvert at a lower value, which means lower taxes.

Rebalance and Consolidate. After you’re done converting, you can put the Roth IRAs back together for a more simplified record keeping.

Keep Good Records. The paperwork on this one could get very complicated if you take it to the extreme. Be sure to keep good records so you don’t make tax time next year a real headache!

Communicate Clearly. If you have multiple accounts, you’ll need to work closely with your broker to make sure the correct conversions and recharacterizations take place. I’ve done Roth IRA conversions and recharacterizations at both Scottrade and Vanguard before without any issues.

More Helpful Roth IRA information:

• 2010 Roth conversion
• Aggressive Roth IRA conversion strategy case study
• Tax treatment of Roth conversion
• How to Make Early Roth IRA Withdrawals

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We’ve been talking about Roth IRA conversions all week. To recap, the 2010 Roth conversion rules mark the first year that there is no income limit for Roth IRA conversion eligibility. Because of that, many people have access to a Roth IRA for the first time.

While you shouldn’t rush into a Roth IRA conversion, there are many instances where a conversion will leave you in a better financial situation over the long term. When deciding whether a Roth conversion is right for you, there are two main things to consider: the effect on your finances during the year of Roth conversion, and the effect at retirement.

Consider a Roth Conversion if:

• You believe you will be in a higher tax bracket during retirement. When you convert, the conversion amount will count as income and you will pay taxes on pre-tax contributions plus growth using today’s tax brackets. You’ll get hit with a larger bill up front because you’re paying on all of it, but if you anticipate a rise in overall tax rates or your own personal bracket, you’ll pay less per dollar of withdrawals by converting today. Plus, paying taxes now and converting means you never have to pay on future earnings. However remember that many people find themselves in lower brackets come retirement age.
• You cannot contribute new funds to a Roth IRA. If you are over the Roth IRA contribution limits, you can now contribute to a traditional IRA and convert each year – but you never know if the rules will change. Converting what you have now is your best chance to take advantage of the tax breaks offered by a Roth.
• You are over 70 ½ and do not need access to your rollover-eligible funds. IRA account owners must take taxable minimum distributions each year after attaining the age of 70 ½, but Roth IRAs do not have the same requirement. Roth funds can sit in the account untouched until the owner’s death. If you do not need the income in future years, you can preserve the funds for your heirs by paying taxes on the rollover and letting your funds continue to grow tax free. If you believe your children or grandchildren will be in a lower tax bracket after your death, you may want to skip conversion and let them pay (lower) taxes later instead.
• Your IRA contributions have dropped in value. If you convert funds that have dropped in value, you only have to pay taxes on what you actually convert – even if it’s less than you originally contribute. If we continue to experience a rebound from the stock market lows, you’ll enjoy tax-free growth after conversion. And if by chance your funds continue to drop, you can do a recharacterization back to a traditional IRA and get some of your tax payment back.

Hold Off or Only do a Partial Roth Conversion if:

• You would tap the conversion amount to pay taxes. In order for a conversion to make sense at all, you must be able to pay the taxes on the conversion amount from outside your retirement funds. Using funds to pay the tax bill lowers the amount of money you have available to grow tax free and withdraw in retirement. Plus, you may face a penalty if you’re under 59 ½. If you want to convert only your nondeductible IRA contributions, you can do so using a special Roth IRA conversion strategy.
• Your conversion amount would place you in a higher tax bracket. If doing a full conversion will place you in a new tax bracket, you may wish to convert over a few years. For example, say you have $10,000 before moving into the 28% bracket, and you have $25,000 to convert. If you convert all now, you’ll pay 25% on $10,000 and 28% on the remaining $15,000. Alternatively, you can convert $10,000 this year (at 25%) and another $10,000 next year, also at 25%. Remember that the special provisions for spreading out your tax bill only apply to conversions done in 2010.
• You expect to be in a lower tax bracket at retirement. If you expect to be in a much lower tax bracket at retirement, it may not make sense to convert now. The final decision depends on how many years you have until retirement and how much growth you expect. If you are relatively young and expect high appreciation, it might make sense to pay a high tax rate on a lower amount. But if you have only a few years until retirement, chances are the math for conversion doesn’t quite work out.
• You want to avoid increased taxation of your Social Security Benefits and/or Medicare premiums. IRA conversions basically count as income for tax purposes – and for purposes of calculating Medicare premiums and the taxation of your Social Security Benefits. Of course these adjustments will only matter for one year, so this shouldn’t be a huge factor in your decision.

Additional Resources

Converting to a Roth IRA is a good idea for many people, but figuring out all the possibilities and implications can be an intense process! Jeff over at Good Financial Cents has an excellent post detailing the calculations, considerations and tax consequences of a few sample rollovers. He pays attention to some intricate details that are a big help to anyone seriously considering a rollover. You can also check out this roundup of conversion calculators over at ConsumerBoomer. If you’re over 70, read about some special considerations over at Vanguard. And of course, don’t forget that it’s always a good idea to check with a tax professional and/or financial planner to make sure that your plan is the absolute best for your personal circumstances.

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As mentioned yesterday in How to Make a Roth IRA Conversion, some special rules went into effect on January 1 that make 2010 Roth IRA conversions more attractive than ever.

If you haven’t yet, you should really consider converting to a Roth IRA this year. This is especially true if you do not qualify to contribute to a Roth IRA and have been unable to reap its benefits.

2010 Roth Conversion Rules

Rules specific to 2010 roth conversions include the following:

• No income limits: For the first time ever, all taxpayers can rollover a traditional IRA to a Roth IRA, regardless of income. So if you’ve had too high of an income to contribute to a Roth, and took advantage of a deductible or non-deductible traditional IRA instead, you can convert all contributions plus growth to a Roth – paying taxes on the converted amount but then enjoying tax-free growth forever. As of now, this provision is permanent.
• Extension of tax payment: Ordinarily, taxes are due on all IRA account growth as well as any deductible contributions. In 2010, you can actually defer paying taxes on the converted amount by completing the conversion in 2010 but claiming half the income in 2011 and half in 2012 – meaning half of the actual tax payment could be deferred to spring of 2013! You can also elect to pay all taxes in 2010. Be aware that you will pay taxes at your rates in those years, so you should pay now if you expect your personal bracket to increase. Spouses can make different elections, but each taxpayer has to apply the same election to all accounts – you can’t choose to pay taxes on one IRA but defer them on another. This election is special for 2010 and will expire in 2011.  

Other Roth Conversion Rules

Other than the two mentioned above, Roth conversion rules remain the same. So remember:

• Contribution limits remain the same. 2010 Roth IRA limits haven’t changed. If you are over the income limits for Roth IRA contributions, you cannot contribute new funds to a Roth. However, as long as the special 2010 roth conversion rule above exists, you can contribute to a traditional IRA and immediately convert.
• Pro-rata rules apply. If you do choose to go the conversion route, you don’t have to convert all your funds. One reason to do it in pieces is to spread your tax bill over many years. However, if you have made both deductible and nondeductible IRA contributions, any partial conversion will be deemed to come from both pools, in a ratio equal to your original contributions. What this means is, you can’t avoid taxes by choosing to convert only nondeductible contributions. However, if you’re willing to put in some work, there is a Roth conversion workaround strategy.
• Regardless of the timing, taxes will be due. At some point, you will owe taxes on your Roth conversion, whether you choose to defer them or not. You should only convert if you can afford to shoulder the tax bill with non-retirement funds. If you use part of the converted amount to pay taxes, you miss out on the compounding growth and may face an early withdrawal penalty.

Check back tomorrow to find out Should You Do a Roth Conversion?

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