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What Role Will Social Security Play in Retirement?
PRACTICE STRATEGIES
What Role Will Social Security Play in Retirement? Kenneth E. Hicks mericans nearing retirement age have historically relied on our Social Security system for additional income—and optometrists are no exception. But, given recent political discussions and assertions by the Bush administration that the system is going broke, can Social Security be counted on by the millions of baby boomers who are getting ready to depend on it to support their retirement? Considering the current complexity of the system,
A
The current status of the Social Security system suggests that, for many ODs, additional resources will be necessary to adequately plan for retirement. should Social Security even be a factor in retirement planning? Some historical and statistical facts related to Social Security include: ❖ When Social Security was created in the 1930s, the average life expectancy was 63 years. Today, that number has increased to 78 years, according to the Statistical Abstract of the United States published by the United States Department of Commerce. ❖ All 78 million baby boomers—America’s largest generation—are now older than 40. Twenty years from now, 1 in every 4 adult
(Kenneth E. Hicks, CPA, is a partner in the firm of May and Company, LLP, established in 1922, with offices in Louisiana, Mississippi, and Alabama. The firm consults with optometrists in 27 states, assisting with their tax planning and preparation, QuickBooks support, and business planning. He can be reached at 601-636-0096 or by e-mail at [email protected]. Opinions expressed are those of the author and not necessarily those of AOA.) 484 OPTOMETRY
Americans will be older than 65, according to the Bureau of Labor Statistics. ❖ According to the Social Security Administration (SSA), the simple demographics for the current system indicate the number of contributors will dwindle relative to a rising number of recipients. Also according to the SSA, although there were 5.1 workers per Social Security beneficiary in 1960, there are only 3.3 workers per beneficiary today, and there will be only 2.1 workers per beneficiary in 2031. ❖ The SSA notes that under current law, each generation receives higher benefits than that of the previous generation. By the year 2017, the system will begin paying out more in benefits than it collects in taxes. According to the program’s trustees, by the year 2041, all reserves will be exhausted and the system will be able to pay only 74% of estimated benefits. Social Security currently has a $4 trillion hole that needs to be filled. President Bush is proposing the creation of personal accounts in the system. Congress is lukewarm to that proposal and, if the plan dies, the program’s looming financial problems will still remain. Unfortunately, this uncertainty adds even more complexity to what is already a somewhat overwhelming process for many aging VOLUME 76 / NUMBER 8 / AUGUST 2005
PRACTICE STRATEGIES
workers, making sure their an OD grossing $500,000 to money—at least their inhave an annual tax savings In this accountant’s come—lasts as long as they of up to $6,000 each year. do. For instance, the unincoropinion, today’s With the long-term viaporated practitioner who bility of this system in earns $100,000 a year will practitioners should question, what are some pay $22,000 in federal inother options for optomecome tax and another plan to provide most, $12,000 in payroll taxes. trists looking forward to retirement? In this accounBy converting the practice if not all, retirement to an S-corporation, the OD tant’s opinion, today’s practitioners should plan to can draw a reasonable salfunds from their own ary—$60,000, for examprovide most, if not all, retirement funds from their ple—and take $40,000 in a sources, and the best nonpayroll distribution. own sources—and the best way to do that is to focus Income tax is still owed on way to do that is to on options that are within the entire $100,000. But their control rather than there are no payroll taxes focus on options that owed on the $40,000 distrirelying on the government to act in their best interest. bution. This results in a tax Electing S-Corporation savings of $4,500. That first are within their (S-Corp) status for the pracyear savings alone can tice and investing in an inmore than justify convercontrol rather than dividual retirement account sion to a subchapter S. (IRA) are two options that In the early 1980s, Conrelying on the offer a self-employed opgress passed an excellent tometrist a method for congovernment to act in piece of tax legislation trolling current expenses when it created the indiand financing retirement. vidual retirement account. their best interest. With payroll taxes an The original IRA was simever-increasing reality, the ple. Individuals got an inpopular S-Corp offers a come tax deduction and way to control tax expenses. By converting the had a tax-deferred savings account by contribpractice to an S-Corp, the OD can take a reauting to an IRA. sonable salary and an annual distribution of Through the years, Congress has changed profits. The distribution is not subject to paythis simple savings plan and made it much roll taxes. An additional benefit is that it promore complex. IRAs have been expanded to vides a recurring annual tax savings if profits include traditional IRAs, Roth IRAs, simplified and salary continue at the same level. employee pension plans (commonly known as The vice-presidential debate of last fall ofSEP-IRAs), simple IRAs, spousal IRAs, nonrefered an interesting illustration of just how this fundable IRAs, and even “stretch” IRAs. As if strategy is being used by other professionals. that were not confusing enough, Congress also During the debates, Vice President Dick created income limitations, phase-out rules, Cheney noted that Senator John Edwards operearly withdrawal penalties with exceptions, ates his law practice as an S-Corp to save prohibited transactions rules, and traditional taxes. In 1998, it was reported that Senator EdIRA-to-Roth conversion rules. wards netted $5 million in his law practice opCongress has now connected IRAs to Social erating as an S-Corp while paying himself a Security with a special tax computation re$360,000 annual salary. This compensation quired when a taxpayer receives Social Secustructure saved him more than $100,000 in rity benefits, makes an IRA contribution, and payroll taxes that year. is subject to the IRA phase-out as an active Because few, if any, optometrists net $5 milparticipant in an employer-sponsored pension lion per year, their tax savings certainly will plan. In 2002, Congress passed an additional not equal $100,000. However, it is possible for IRA provision. Termed the catch-up provision, 485 VOLUME 76 / NUMBER 8 / AUGUST 2005
OPTOMETRY
PRACTICE STRATEGIES
it is for those who are 50 years or older who have not adequately provided for their retirement. A case can be made that if Congress had left the original IRA program as it was at the time, there would be no need for all the new catch-up provisions. But even as complex as IRAs have become, they still provide a good retirement planning tool and should be part of the practitioner’s portfolio, with consideration given to income limitations. In addition to these two resources, what are other areas an OD should explore when thinking about Social Security and retirement? Here are some additional suggestions: 1. Consider putting off retirement an extra 3 to 5 years. If you do retire, plan to work part-time as a contract OD. 2. Prepare a personal budget each year with income and expenses. If necessary, downsize your home and your standard of living. Consider relocating to a more affordable part of the country.
3. Consider anything received from Social Security a bonus—and keep retirement planning simple. Assume that retirement will be entirely funded by personal savings, your retirement plan, the fair market value of your practice, and your building (if you own it). Understanding the plans Congress makes for the Social Security program can be difficult, and even what is understood will surely change. If the practitioner assumes zero output from Social Security, controls expenses that go into the Social Security program, uses an SCorp as the practice entity, and invests in an IRA or other qualified retirement plan, planning options become much simpler and within reach. These are resources that make it possible to prepare for retirement with some measure of confidence.
486 OPTOMETRY
VOLUME 76 / NUMBER 8 / AUGUST 2005
What Role Will Social Security Play in Retirement? Kenneth E. Hicks mericans nearing retirement age have historically relied on our Social Security system for additional income—and optometrists are no exception. But, given recent political discussions and assertions by the Bush administration that the system is going broke, can Social Security be counted on by the millions of baby boomers who are getting ready to depend on it to support their retirement? Considering the current complexity of the system,
A
The current status of the Social Security system suggests that, for many ODs, additional resources will be necessary to adequately plan for retirement. should Social Security even be a factor in retirement planning? Some historical and statistical facts related to Social Security include: ❖ When Social Security was created in the 1930s, the average life expectancy was 63 years. Today, that number has increased to 78 years, according to the Statistical Abstract of the United States published by the United States Department of Commerce. ❖ All 78 million baby boomers—America’s largest generation—are now older than 40. Twenty years from now, 1 in every 4 adult
(Kenneth E. Hicks, CPA, is a partner in the firm of May and Company, LLP, established in 1922, with offices in Louisiana, Mississippi, and Alabama. The firm consults with optometrists in 27 states, assisting with their tax planning and preparation, QuickBooks support, and business planning. He can be reached at 601-636-0096 or by e-mail at [email protected]. Opinions expressed are those of the author and not necessarily those of AOA.) 484 OPTOMETRY
Americans will be older than 65, according to the Bureau of Labor Statistics. ❖ According to the Social Security Administration (SSA), the simple demographics for the current system indicate the number of contributors will dwindle relative to a rising number of recipients. Also according to the SSA, although there were 5.1 workers per Social Security beneficiary in 1960, there are only 3.3 workers per beneficiary today, and there will be only 2.1 workers per beneficiary in 2031. ❖ The SSA notes that under current law, each generation receives higher benefits than that of the previous generation. By the year 2017, the system will begin paying out more in benefits than it collects in taxes. According to the program’s trustees, by the year 2041, all reserves will be exhausted and the system will be able to pay only 74% of estimated benefits. Social Security currently has a $4 trillion hole that needs to be filled. President Bush is proposing the creation of personal accounts in the system. Congress is lukewarm to that proposal and, if the plan dies, the program’s looming financial problems will still remain. Unfortunately, this uncertainty adds even more complexity to what is already a somewhat overwhelming process for many aging VOLUME 76 / NUMBER 8 / AUGUST 2005
PRACTICE STRATEGIES
workers, making sure their an OD grossing $500,000 to money—at least their inhave an annual tax savings In this accountant’s come—lasts as long as they of up to $6,000 each year. do. For instance, the unincoropinion, today’s With the long-term viaporated practitioner who bility of this system in earns $100,000 a year will practitioners should question, what are some pay $22,000 in federal inother options for optomecome tax and another plan to provide most, $12,000 in payroll taxes. trists looking forward to retirement? In this accounBy converting the practice if not all, retirement to an S-corporation, the OD tant’s opinion, today’s practitioners should plan to can draw a reasonable salfunds from their own ary—$60,000, for examprovide most, if not all, retirement funds from their ple—and take $40,000 in a sources, and the best nonpayroll distribution. own sources—and the best way to do that is to focus Income tax is still owed on way to do that is to on options that are within the entire $100,000. But their control rather than there are no payroll taxes focus on options that owed on the $40,000 distrirelying on the government to act in their best interest. bution. This results in a tax Electing S-Corporation savings of $4,500. That first are within their (S-Corp) status for the pracyear savings alone can tice and investing in an inmore than justify convercontrol rather than dividual retirement account sion to a subchapter S. (IRA) are two options that In the early 1980s, Conrelying on the offer a self-employed opgress passed an excellent tometrist a method for congovernment to act in piece of tax legislation trolling current expenses when it created the indiand financing retirement. vidual retirement account. their best interest. With payroll taxes an The original IRA was simever-increasing reality, the ple. Individuals got an inpopular S-Corp offers a come tax deduction and way to control tax expenses. By converting the had a tax-deferred savings account by contribpractice to an S-Corp, the OD can take a reauting to an IRA. sonable salary and an annual distribution of Through the years, Congress has changed profits. The distribution is not subject to paythis simple savings plan and made it much roll taxes. An additional benefit is that it promore complex. IRAs have been expanded to vides a recurring annual tax savings if profits include traditional IRAs, Roth IRAs, simplified and salary continue at the same level. employee pension plans (commonly known as The vice-presidential debate of last fall ofSEP-IRAs), simple IRAs, spousal IRAs, nonrefered an interesting illustration of just how this fundable IRAs, and even “stretch” IRAs. As if strategy is being used by other professionals. that were not confusing enough, Congress also During the debates, Vice President Dick created income limitations, phase-out rules, Cheney noted that Senator John Edwards operearly withdrawal penalties with exceptions, ates his law practice as an S-Corp to save prohibited transactions rules, and traditional taxes. In 1998, it was reported that Senator EdIRA-to-Roth conversion rules. wards netted $5 million in his law practice opCongress has now connected IRAs to Social erating as an S-Corp while paying himself a Security with a special tax computation re$360,000 annual salary. This compensation quired when a taxpayer receives Social Secustructure saved him more than $100,000 in rity benefits, makes an IRA contribution, and payroll taxes that year. is subject to the IRA phase-out as an active Because few, if any, optometrists net $5 milparticipant in an employer-sponsored pension lion per year, their tax savings certainly will plan. In 2002, Congress passed an additional not equal $100,000. However, it is possible for IRA provision. Termed the catch-up provision, 485 VOLUME 76 / NUMBER 8 / AUGUST 2005
OPTOMETRY
PRACTICE STRATEGIES
it is for those who are 50 years or older who have not adequately provided for their retirement. A case can be made that if Congress had left the original IRA program as it was at the time, there would be no need for all the new catch-up provisions. But even as complex as IRAs have become, they still provide a good retirement planning tool and should be part of the practitioner’s portfolio, with consideration given to income limitations. In addition to these two resources, what are other areas an OD should explore when thinking about Social Security and retirement? Here are some additional suggestions: 1. Consider putting off retirement an extra 3 to 5 years. If you do retire, plan to work part-time as a contract OD. 2. Prepare a personal budget each year with income and expenses. If necessary, downsize your home and your standard of living. Consider relocating to a more affordable part of the country.
3. Consider anything received from Social Security a bonus—and keep retirement planning simple. Assume that retirement will be entirely funded by personal savings, your retirement plan, the fair market value of your practice, and your building (if you own it). Understanding the plans Congress makes for the Social Security program can be difficult, and even what is understood will surely change. If the practitioner assumes zero output from Social Security, controls expenses that go into the Social Security program, uses an SCorp as the practice entity, and invests in an IRA or other qualified retirement plan, planning options become much simpler and within reach. These are resources that make it possible to prepare for retirement with some measure of confidence.
486 OPTOMETRY
VOLUME 76 / NUMBER 8 / AUGUST 2005