What are you going to do about Gov. Chris Christie’s plan to balance the budget by confiscating your Social Security account? Don’t shrug it off as politically impossible. This kind of trouble has been brewing for a long time, and someday, probably within a decade, something awful like this will be enacted. It’s not too soon to think about defensive measures.
The governor/presidential aspirant wants to phase out benefits for retirees making $80,000 to $200,000 and eliminate them for those above that range. It sounds utterly radical, but in fact it is not radical at all. It’s a continuation of a long tradition of taking money from frugal people on the theory that they don’t need it.
Social Security benefits were once 50% taxable, the plausible argument being that half of them were funded by pretax dollars (coming from employers). The current formula, which makes benefits as much as 85% taxable, is just the Christie wealth redistribution system on a smaller scale.
We also have in place a Medicare premium surcharge that hits retired couples with incomes above $170,000. At the top end, the formula creates a $7,238 annual surtax.
Then there was the short-lived “success tax,” which imposed a penalty on retirees who took too much out of their IRAs, even if the amount being taken out was equal to the minimum demanded by another rule (under pain of another penalty). That tax has been repealed but could come back in some form. You get a taste of it in the Obama administration proposal to limit the size of IRAs.
So, bad stuff is already happening, and worse things will happen, to people who save for their retirement. What can you do about it? I can think of five ways to reduce the damage from the governor’s plan, or one structured like it.
1. Do a Roth conversion. Let’s say you have $1 million in your pretax IRA and would have to withdraw it, beginning at age 70-1/2, at a rate of $36,500 a year. This might tip you into the phase-out territory. You could lessen the damage by Rothifying some of your retirement money. Roth accounts don’t have mandatory withdrawals and, more importantly, withdrawals aren’t included in income.
When you convert, you pay income tax up front on your IRA. To keep from boosting yourself into a higher tax bracket, spread the conversion over many years. Start thinking about this when you are 45, not 65.
Opting to put some of your 401(k) money into a Roth 401(k) has the same effect.
2. Own low-dividend stocks. Dividends get a reduced tax rate but count fully in the adjusted gross income number that will probably drive future penalties of the Christiean sort.
Think about this as soon as you start building up assets in your taxable account—when you are young, that is. If you sail into retirement holding big dividend payers bought long ago, it may not be easy to switch gears when Social Security kicks in. If the long-held stocks are appreciated, selling them would create capital gains. The gains would aggravate the AGI problems you are trying to avoid.
Examples of stocks to own in a redistributionist world: AutoZone (AZO), Google (GOOG). Examples of stocks not to own: Verizon (VZ), Annaly Capital Management (NLY).
3. Bunch capital gains. Let’s say a flow of capital gains from your portfolio, combined with other retirement income, gives you a steady $200,000 income. If you could only bunch the gains into odd years, maybe you could arrange an AGI that oscillates between $80,000 in even years and $320,000 in odd years. That would preserve half your Social Security.
If you own an index fund you can control the timing of gains. If you own an actively managed mutual fund, you can’t. Index funds I like: Vanguard Total Stock Market (VTI), Schwab U.S. Broad Market (SCHB).
4. Invest in master limited partnerships. For the first several years you own an energy partnership, your dividends are likely to be mostly tax-free. Then, when you sell, you get a delayed-reaction tax on the dividends. Example: Enterprise Products Partners (EPD).
Strategy: When you retire, buy a collection of MLPs, coast for seven years, and then in the eighth year bite the bullet and liquidate. You’ll be Christied out of Social Security only in the eighth year.
5. Own tax-exempt bonds. Once you are retired, owning municipal bonds does limited good because the penalties and phase-outs we’re talking about usually count muni interest in the definition of income. Municipals, though, are also a way to build wealth during your working years. Unlike an IRA or an appreciated stock you end up selling, that muni bond account will not create a delayed burst of income when you turn 70. Consider buying munis at age 45 and redeeming them at age 70.
Caution: Don’t buy bonds from New Jersey. It’s close to bankrupt.
