Financial Independence Daily FI discussion thread - February 25, 2020

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• Daily FI discussion thread - February 25, 2020
• How the Backdoor Roth and Pro Rata Rule work (Another Animated Diagram)
• Social Security and FIRE
• 401k Anti-Discrimination Testing

Daily FI discussion thread - February 25, 2020 Posted: 25 Feb 2020 12:08 AM PST Please use this thread to have discussions which you don't feel warrant a new post to the sub. While the Rules for posting questions on the basics of personal finance/investing topics are relaxed a little bit here, the rules against memes/spam/self-promotion/excessive rudeness/politics still apply! Have a look at the FAQ for this subreddit before posting to see if your question is frequently asked. Since this post does tend to get busy, consider sorting the comments by "new" (instead of "best" or "top") to see the newest posts. submitted by /u/AutoModerator [link] [comments]

How the Backdoor Roth and Pro Rata Rule work (Another Animated Diagram) Posted: 25 Feb 2020 04:10 AM PST I think animations really help explain some of the more complicated tax stuff involved in early-retirement strategies and US retirement accounts. I made this one to explain the Backdoor Roth contribution, how it allows you to bypass IRA income limits, and how the pro rata rule works. The Video: Backdoor Roth and Pro Rata Rule Explained The video is hosted on streamable, so there's no self promotion, branding, or monetization on my part. Just want to share the content. Previous animated diagram on the Roth Conversion Ladder All of this only applies to the U.S. System! submitted by /u/welliamwallace [link] [comments]

Social Security and FIRE Posted: 25 Feb 2020 04:38 AM PST I figured this might make an interesting top-level discussion, and given all the recent drama about too few posts, well, be the change you want to see and all that. I'm positing that this is a valuable discussion topic because I've seen confusion on this sub about how Social Security works and whether or not you should even consider it in your FIRE plans. Given that many people here plan on retiring early, I think it's helpful to understand the eligibility requirements and mechanisms of the program. Disclaimer: There are many contexts I'm not considering here, like teachers who pay into a pension system instead of Social Security. I'm writing this from the perspective of someone in the private sector in the US for their whole career. I'm not covering non-US citizens who have paid into Social Security or US citizens who worked abroad. Finally, I am not an expert, I'm just an internet stranger who has read a bit about the program. If I got something wrong, please correct me in the comments, we're all striving for a more perfect understanding. What is Social Security? It's officially called Old-Age, Survivors, and Disability Insurance. For the purposes of this discussion, I'll focus on the old-age part. It is not a retirement vehicle where your individual contributions are placed for your later withdrawal, rather it functions more like a QLAC (qualified longevity annuity contract), but with a strong tilt toward social safety net. It was officially signed into law in 1935 with an aim of reducing poverty among the elderly. From recent CBPP research on Social Security and poverty: Without Social Security, the poverty rate for those aged 65 and over would meet or exceed 40 percent in one-third of states; with Social Security, it is less than 10 percent in two-thirds of states. Alternatively an excerpt from the PGPF: Social Security drastically reduced poverty for the elderly. Without income from Social Security, two thirds of the elderly would be considered poor. Social Security reduced the poverty rate to 16 percent in 2008. How are benefits determined? Credits To be eligible for Social Security you need a minimum of 40 "credits". As of 2020 you earn a credit for every $1,410 with a maximum of 4 credits per year. So if you make at least $5,640 / year (in today's dollars) for ten years then you're eligible. In keeping with the spirit of the program there's a low barrier to qualify for the most basic level of benefits. Averaged Indexed Monthly Earnings (AIME) Social Security keeps track of your eligible annual earnings. When calculating your benefits, they will count your top 35 years. If you've worked less than 35 years, you've got zeros counting against you. Past years earnings are adjusted for inflation by using multiplier values which the SSA maintains a list of. Your AIME is then calculated by taking the adjusted total of those highest 35 years of earnings, dividing by 35, and then dividing by 12. So if your total indexed earnings were $1,000,000 as of today, your AIME would be: $1,000,000 / 35 / 12 = $2,380 Income caps Social Security places a cap on how much of your annual earnings count towards your AIME, in 2020 this cap is $137,700. It doesn't matter if you earn more, this is maximum value that will go into your earnings history for the year. That may sound unfair at first brush, but past this point you also stop paying Social Security taxes on income. Primary Insurance Amount (PIA) Now we get to the part people really care about, your AIME is translated into a PIA through a formula. PIA is what your monthly payment would be at full retirement age. How does this formula work? You can read it from the source here. The short of it is that there are two bend points in the PIA curve, you can think of it as three brackets where each bracket gives you a worse return than its predecessor. For AIME <= $960, you get 90% income replacement For AIME > $960 and <= $5,785 you get 32% income replacement For AIME > $5,785 you get 15% income replacement This is where the social safety net behavior becomes most apparent, it's easy to qualify for the first $864 in monthly social security benefits since you get 90 cents on the dollar, but progressing beyond this is much slower going as you pass the first bend point and slower still when you hit the second bend point. Let's run an example, carrying over our $2,380 AIME from earlier: $960 * .9 = $864 $1,420 * .32 = $454 $0 * .15 = $0 = $1,318 This mean Social Security would pay you $1,318 a month at 67. There's a whole different calculation for starting benefits earlier or later which decreases or increases your payments, but I'll leave that for another discussion. RIP Social Security Isn't Social Security running out of money? I hear this a lot. Invariably when Social Security comes up in the daily thread you'll see some people say they don't even count it because they don't think it'll be around when they retire. It's true that Social Security is paying out more money than it takes in but this is a recent development. Over the last few decades the program actually ran an overall surplus which went into a trust fund and was invested into treasury securities. That trust fund has $2.9 trillion dollars. You'll see people say that Social Security went into a deficit in 2010, which is true on a taxes in vs benefits out basis, but that ignores the interest income that Social Security receives from its invested trust fund assets. Up until 2020 or 2021, that interest income has been enough to make up the shortfall. Unfortunately this means Social Security is now starting to eat its nest egg. Under current projections, the trust fund has enough money to allow full payouts until 2034. But what about after that, game over? Not quite, if the trust fund is fully depleted, Social Security will only be able to pay out in benefits what it receives in taxes. As of right now, that's projected to be about 77 cents on the dollar. What that means is, if nothing else happens between now and trust fund depletion, you'll take a 23% haircut on your projected benefits. That's not great, but it's a far cry from the whole system imploding. No, seriously, I heard Social Security was going to explode Every so often someone will write a scary story with obscenely large numbers. These are almost invariably based on the infinite horizon projections in the annual Social Security trustees report. The infinite horizon projection takes the 75 year projection and extends it into infinity. If this sounds like it might not produce sane numbers, many actuaries agree with you: The infinite horizon projections project all annual balances beyond 75 years assuming that the current law, demographic assumptions, and economic trends from the 75-year projection continue indefinitely; in practice, this is highly problematic. Projections over an infinite time period have an extremely high degree of uncertainty. Troublesome inconsistencies can arise among demographic and program-specific assumptions. By assuming that longevity keeps increasing forever while retirement ages remain static, for example, the infinite time period forecast will eventually result in an extremely long period of retirement. What's FIRE got to do with it? That was all interesting, but what are the takeaways for someone interested in FIRE? Make sure you're eligible First and foremost, get those 40 credits! Unless you strike it very rich early on, it's a good hedge to make sure you're eligible for at least the basic levels of Social Security benefits. You're hopefully looking at a long retirement and these payments may help considerably twenty or thirty years down the line. Max out the first segment of the PIA curve If you work for at least ten years and make >= $40k / year, you'll both qualify for Social Security benefits and fill up the first (and most generous) part of the PIA curve. For most people here it'll probably just happen as a matter of course. Be realistic about Social Security It's extremely conservative to entirely exclude Social Security from your plans. Pricing in a haircut seems prudent. Even if political action is taken to shore up finances, it may have the same net effect to a well-off FIRE person (i.e. heavier taxation of benefits, means testing, etc). I'd be wary of simply taking the stated monthly benefits you see now at face value if your benefits are more than 10 years out. A couple of naive strategies Here are two different ways I've thought of Social Security over the years in my plans. I'm not presenting these as recommendations or fully formed plans, but providing them as an example. Safe withdrawal rate Goal: Boost your starting SWR by accounting for your eventual Social Security benefits ERN has an interesting write-up that discusses accounting for Social Security cash flows when planning your safe withdrawal rate. Admittedly he does not think it changes much for very early retirees, but depending on when you retire and what your expected benefits are, Social Security can have a non-trivial impact on your SWR. Longevity insurance Goal: Guard against an unexpectedly long life In this scenario you're mostly planning on your own funds to see you through your early retirement, and you want to maximize the cash flow from Social Security in the event that you somehow live to 90 or beyond. In this case you'd want to defer your benefits as long as possible (70 years old) to increase the monthly benefit. The downside to this approach is that if you don't live that long (say you keel over at 75), you've made a sub optimal choice with regard to total payout. In the context of insurance though, this is could be a fair trade-off. A QLAC or deferred annuity is a more straightforward proposition for such hedging but for most people Social Security is mandatory anyway. Be aware of your progress You can check on your current credits, AIME and PIA by plugging your numbers into https://ssa.tools/. I've got no connection with this page, I just think its a nifty tool. You can get your numbers by signing into your ssa.gov account. Note: If you're just signing up for an ssa.gov account, be aware that they need to pull your credit information from Equifax to verify your identity, so if you've frozen your credit with Equifax, you'll actually have to do a temporary lift before applying. Yes, everything about that last sentence is ridiculous. From their account creation page: If you have a security freeze, fraud alert, or both on your credit report, you can still open a my Social Security account by temporarily lifting it. Spousal benefits Another fun tip is that if you're married and your partner has a much lower income and / or becomes a stay at home parent, you can look into spousal benefits. This lets your partner receive a monthly benefit equal to 50% of your own regardless of their work record. Obviously you'd want to crunch the numbers to see if your partner is eligible for a larger benefit based on their own earnings history. Retiring abroad Retiring abroad is a common theme amongst a certain segment of the FIRE population. SSA provides a full page of information regarding receiving payments while outside the US. The short answer is that if you're a US citizen who is eligible for benefits, you should be able to get your payments regardless of where you live, so long as that where isn't North Korea or Cuba. They even provide a guided questionnaire to help you determine if payments will work in your specific situation. Conclusion At the end of the day, Social Security is a safety net more than it is a retirement mechanism. Its goal is to help cash strapped seniors make ends meet, not support a great or even good retirement on its own. For many people here, however, it represents a non-trivial cash flow on the back end of their retirement and it shouldn't be dismissed lightly. Don't assume Social Security will look or pay the same 30 years from now. On the flip side there would be objectively bad outcomes for a significant portion of the elderly population if it went belly up. I could be wrong, but I don't think eliminating Social Security would be a popular political agenda. That's about as long a wall of text as I am willing to write, and probably longer than most people are willing to read. For those of you that did read it through, I hope it helped. submitted by /u/FancyPantsFIRE [link] [comments]

401k Anti-Discrimination Testing Posted: 25 Feb 2020 04:18 PM PST Hi all! I came across an issue today with our company's 401k that really has me steaming. Our company has 28 FTE's - all are eligible to contribute to their account with a 3% company match. Each year, we are required to test whether highly compensated employees are contributing more than non highly compensated ones. As I understand it - someone please correct me if I have this wrong - if the highly-compensated ones contribute more than the others in total, then we are discriminating against the non highly compensated employees because they choose to not contribute. Our company failed the test this year because we're a small company and those of us who are highly compensated are also above 50 and have maxed our contributions including the catch-up provision. The solution our HR person is hearing is that the plan must refund to the highly compensated employees the amount that they contributed in excess or our plan might be in jeopardy. Someone please tell me there is an alternate solution to this madness. How can it be discriminatory if all employees are offered the same opportunity to contribute and the same match? submitted by /u/Yarntopia [link] [comments]

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