NerdWallet's Smart Money Podcast - Your Social Security Benefits, and Tax Efficient Retirement Investing

Episode Date: May 1, 2023

Knowing how much you could get from Social Security is a big part of retirement planning (and, yes, cynical listeners — you will be getting these benefits!). To kick off this episode, Sean and Liz talk about a new tool that can help you estimate your benefits.  Then Sean and Sara answer a listener’s question about tax efficient investments for retirement accounts.  Need help with a money question? Call or text the Nerd hotline at 901-730-6373 or email [e-mail]. You can also email us your voice memos.  Timestamps: This Week in Your Money segment: 0:00 - 10:45  Money Question segment: 10:46 - 31:02  Like what you hear? Please leave us a review and tell a friend.

Choosing the right investments for your retirement accounts can be a head-spinning endeavor. Do you continually tweak your investment mix or just let things ride? And how do you choose between retirement accounts like 401ks and Roth IRAs? Well, this episode, we will help a listener sort out their retirement investment decisions. Welcome to the NerdWallet Smart Money Podcast, where you send us your money questions and we answer them with the help of our genius nerds. I'm Sean Piles. And I'm Liz Weston. Okay, we'll get to the part where we ask our listeners to send us their money questions in a bit. But first, Liz, welcome back. Hey, it's great to be back. Thank you. So Liz, you had a little eat, pray, love journey through Europe, spent a lot of time in France. Do you have any profound money lessons do the stuff that you want to do. I've been taking paid and unpaid leaves multiple times in my career, and they are so worth doing if you can

swing it. That sounds lovely. Well, I am glad that you're back. And listeners, just so you know what's up on our end too, my other co-host Sarah Rathner is about to head off on her own spiritual journey called maternity leave. So Liz will be back in the hosting seat with me over the next few months. All right. And now we are at the part where we ask our listeners for their money questions. So to keep it short and sweet, listeners, we know that you have burning money questions

and it is our job to answer them. So send your money questions our way. Maybe you want some advice about how to make the expensive summer travel season more budget friendly, or you're wondering about how to pay for a bathroom remodel, or maybe your question is even less specific. Whatever you're wondering about, please send us your questions. Leave us a voicemail or text us on the Nerd Hotline at 901-730-6373, or you can email us at podcast at nerdwallet.com. This episode, my other co-host, Sarah, and I answer a listener's question about how to

choose the most tax-efficient investments for their retirement account. But first, to kick off this episode, Liz and I are talking about another big part of retirement planning, social security benefits, specifically understanding how much you might get. It's easy to underestimate how important Social Security is going to be to your retirement planning, but it is huge. Every $1,000 in monthly income that you get from Social Security is $300,000 that you don't have to save. Wow.

Yeah. And not only is that income guaranteed for life, but it's inflation adjusted, so your buying power isn't eroded over time. And you don't have to make a bunch of decisions about how to invest the money. It just comes to you. So one of our nerds, Tina Oram, has created a calculator to help you estimate your benefit. Welcome to the podcast, Tina. It's great to be back. Hi. Tina, right about now, a lot of our audience is thinking, I'll never see a dime from Social Security. Yeah. Well, we've been hearing for years that Social Security is going broke.

Yeah. So in March, the Social Security Administration actually released a statistical analysis, and it basically said that that part of Social Security, the so-called trust fund, is going to run out of money in 2034. And at that point, the estimate is that the taxes you and I pay on our earnings, basically a part of it, will still be enough to pay something like 80% of promised benefits. So, I mean, 80% isn't nothing. Yes. And Social Security is the most popular federal program ever. I can't imagine any politician who wants to get reelected allowing people who are getting benefits to have those benefits cut. So the program may change, but it is highly doubtful that it'll go away.

Yeah. And also just to beat back the cynicism among my fellow millennials and my Gen Z brethren, I think the whole Social Security is going to run out of money, so why should we even try kind of defeatism could be a self-fulfilling prophecy. So if folks in my generation really want this benefit, make your voice heard and ensure that it's there for you. The battle is not over, folks. So anyway, Tina, let's hear about this calculator

that you devised. Sure. Yeah, we put this calculator together because we know, right, a lot of people wonder what they're going to get from Social Security and when they're going to get it. And I think that's a reasonable thing to wonder, especially when you're thinking about your retirement savings and those bigger questions of how much money will I need every month and where's that money going to come from? So this calculator is intended to help consumers with that. And I want to be sure to give a shout out to our engineering team, the product team, our editors. We all helped produce this calculator. And I'm saying that not just to be sure to acknowledge and credit the people who worked on this, but I also want to tell people that this

calculator is made by a team of people. And we've edited and tested it. And we put a lot of thought into how to make it useful and easy for consumers. Awesome. So what do people need to know about using the calculator? Okay, a few things. So the first thing I want to say is that the calculator is easy to use. You just enter your date of birth, you enter the age at which you want to start taking Social Security retirement benefits, your annual income this year, and then an estimate of your annual salary increases going forward. So that's it. The second thing I'll say is that this is an estimate. We don't have access to the last 35 years of your personal income and earnings history. So that's what the Social Security Administration uses to calculate your

exact to the penny benefit. So we make an estimate of your previous earnings based on what you tell us you earned this year. So the catch is if you were out of the workforce for several years, or maybe you had income and it fluctuated a ton, or you were in a line of work where they may not have withheld Social Security taxes from your paychecks, your benefits are much harder to estimate with this tool. But if you had a fairly steady paycheck and Social Security tax has been coming out of those checks, this tool should give you what we think is a pretty good estimate of the size of your monthly Social Security retirement benefit check at various points in time. And I say various points because there are three in particular that are of particular interest when it comes to Social Security. There's the age at which you want to retire. There is what Social Security Administration calls your full retirement

age, which I'll get to in a second, and then age 70. Okay, so this might be a good time to remind folks of how Social Security benefits are actually calculated. Tina, can you give us a super quick, simple explanation of this very complicated matter? Yes, because it turns out the formula for calculating Social Security benefits is actually pretty complex. But simply put, how much Social Security tax you pay into the system over time, it influences the size of your eventual that is what I said, the full retirement age. So that's the age at which you're entitled to 100% of your Social Security retirement benefit. And the Social Security Administration decides what your exact full retirement age is, and that's based on when you were born. So for most people, it's sometime between age 66 and 67. I'm guessing for most of

our listeners who were born in 1960 and after, it's going to be age 67. You can start Social Security as early as 62, but you're essentially settling for a permanently reduced check. And why would you do that? This was one of the most interesting parts of the calculator as I was playing around with it, seeing just how much you can get monthly or annually by delaying your retirement, even a year or seven years or something like that. You can get thousands of dollars more per year just by holding off the age at which you receive these benefits. Oh, yeah, it's huge. And there's been a lot of research done over the past few decades showing that most people are better

off waiting. And that's sometimes a hard message to get through is like people want to grab the money when they've got it, but you really do get more than sufficient payoff if you wait. And another cool thing with this calculator is that you see the social security break even age, which is the point at which the amount of benefits you receive, having waited a few years to start getting your benefits, begins to outpace the amount you would have gotten if you started getting them at an earlier age. Yeah. All right. Well, Tina, what should folks do with the information they get from this calculator? Well, I think one good use of this information is to get an idea of what's really going to be available to you when you want to retire. So, for example, if you've used our retirement calculator

and you have an idea of how much money you'll need per month during retirement to live the life that you want to live, then knowing what portion of that is going to come from Social Security can help you get a tighter handle on how much you need to save for retirement. Another thing the calculator I think will get you thinking about is when you want to retire. So if you know that you're going to get a bigger monthly check by waiting to start taking benefits, would waiting work for you? How long is too long? You know, when will it be no longer worth it or affordable to wait?

So that information can sort of help you get on the same page with your partner and kind of with yourself, frankly, about when you're really going to retire. And where can people get more information around Social Security benefits? Yes. Well, NerdWallet does have a ton of helpful content about Social Security on the site. Everything from how it works and different types of benefits that come from the Social Security Administration and what happens to your retirement benefits in certain situations and ways to maximize your benefits. And of course, you can always take a look at the Social Security Administration's website or visit a local Social Security office. And we should mention that if you do have a more complicated situation, you can see your actual Social Security estimated benefits on its website by creating a My Social

Security account. Probably a good thing to do anyway, just to secure that and make sure that nobody else can get your information. But it's a way to see what Social Security's estimates are based on your actual earnings history. All right. Well, Tina, thank you so much for talking with us and for building this super cool calculator. Yeah, my pleasure. I hope it helps people. And with that, let's get on to my money question conversation with Sarah. This episode's money question comes from Amy. Here it is, as read by Smart Money producer Rosalie Murphy. Hi, nerds. I love your podcast, and I wanted to get your take on a question I have. I am in my late 30s, and I am just starting to think about investing for retirement.

I have a decent amount of money in a savings account that I can use to invest. I've done a fair amount of research into investing, and index funds come up a lot as a smart option. My question is, aren't ETFs an even better choice given that they're more tax efficient? I planned buy and hold and don't expect to do much with my investments until I retire. Please help me figure out if ETFs end up costing investors less than index funds do when the time comes to sell them. Thank you. Amy L.

To help us answer Amy's question on this episode of the podcast, we're joined by investing nerd Alana Benson. Welcome back to Smart Money, Alana. Thanks for having me. Alana, it's always so good to have you on because we have so many investing questions, and our listeners do too. But before we get into them, a quick disclaimer that we are not about to give any investment advice. We are not ever going to give you investment advice or tell you what to do with your money. This is for general educational and entertainment purposes. So, okay, let's talk about some different investment vehicles that people can use to invest or save for retirement.

401ks and Roth IRAs are pretty common, but what about straight up brokerage accounts or robo advisor accounts? So I just want to start off by clarifying some language for our listeners. First of all, saving does not equal investing. Saving can mean putting money into a savings account. It can mean stashing your money under your mattress. We do not necessarily say that that's a good idea. Or it can mean putting it into a high-yield saving account. But investing means putting your money into a high yield saving account. But investing means putting your money into a specific investment account, which is different than a bank account, and then purchasing investments from there. So a lot of people use that language interchangeably,

just like to clarify, you know, maybe we say saving for retirement, but really we mean investing for retirement. Yeah. And one key important difference is that when you do have an investment account like a 401k, you have to make sure that the money you're putting into there is being invested because some people will make this really tragic mistake where they'll put money into these accounts for many years and it will not have been invested. And then they're not actually growing their money through investments and compound interest and all of that good stuff. Absolutely. That is a devastating mistake. Yeah, the money defaults to essentially being held in cash in a money market account, same thing almost. So you should just be aware that what the money sits in when you put it in

first before you tell it where to go is essentially cash. Once you tell the money where to go in terms of picking investments and you set up that automatic transfer of money from your paycheck into those investments, that's when you can sit back and hope that the market works your way over the next 30 plus years, which it may or may not do, as we know. Yeah. And I think it's really important as well to talk about where you invest, which means your account type. So a 401k or a Roth IRA, like the actual account type, is just as important as what you actually invest in from that account, which is stocks or bonds or mutual funds. So understanding the difference between an account, which is not actually an investment. So if someone says they're investing in a Roth IRA, the Roth IRA is not the investment that's

going to make them money. It's just the account type where those investments live. So they might be investing in stocks or mutual funds from their Roth IRA. One thing we should probably clarify as well is that we talk a lot about Roth IRAs and 401ks because those are tax-advantaged accounts, and we'll get into what that means more in a little bit. But using a brokerage account or a robo-advisor account for retirement savings is not very common. People typically don't use that as their primary investment vehicle, correct? That depends. I think if it's someone who has a 401k available to them, then that's going to be something that, you know, if you have an employer that offers that, that's great. And 401ks tend to have much higher contribution limits, so you can actually put more money in. But if you don't have an

employer that offers that, or if you are self-employed, then you may be looking for other options. So Sean mentioned 401ks and Roth IRAs, which are two different kinds of investment accounts that are often used for retirement savings. Is there a general order of account types for investing that financial advisors recommend? So typically, the idea is to start with a 401k if you have one. 401ks are great. We talk about them a lot on this podcast. You often get an employer match through them, which equates to free money. So the idea is that you start with a 401k, you contribute enough to get your employer match, and then you consider pausing on that or put as much in that as you want if you don't want to make this complicated. But if you're okay with a couple complications,

once you get your match, then consider IRAs. Traditional IRAs, Roth IRAs. They both have different tax advantages. But the reason that you would move from a 401k to an IRA is because the tax advantage for IRAs is really strong. So you get your match with a 401k, then move to an IRA once you can max that out, then move back to a 401k and you could max out that 401k. I like to think of it almost like a waterfall with buckets. So if water is pouring into the first bucket, you fill up that first bucket. And then once it starts overflowing,

it can start filling up the next bucket. So don't feel stressed out if you can't necessarily do all those things right away. But the first bucket is getting that match. If you can contribute enough to get your match, that's awesome. Then the overflow goes into an IRA. Once you can max that out, then into maxing out your 401k. And what about folks who maybe don't have access to a 401k through an employer? Can you talk about how solo 401ks and SEP IRAs might fit in? Yeah, so solo 401ks are great. They're designed for business owners with no

employees. SEP IRAs are another option. Folks who are self-employed are really going to need to look at their specific circumstance, whether they have employees or if they don't, and figure out what retirement accounts are going to work best for them. That may be a conversation to have with a financial advisor just because those things can get a little complicated. But a really important thing is that once you figure out where, again, that type of account that you want to invest in, maybe the order in which you want to have your money flow through those investment accounts, then you can figure out how you want to invest. So we have the where, which is the account type, the what, which is the actual

investments, and then the how, which is do you want to choose your investments by yourself and manage them by yourself, or do you want to not worry about that? So if you don't want to worry about it, you don't want to think about it or stress about it, you can have a robo-advisor do it for you, which is a pretty low-cost way. These are online algorithms that basically take your risk tolerance, your age, other personal factors into account, and then they build and manage a portfolio for you for a fairly modest fee, which is great. That makes it super easy. You can automate it, have money taken out of your bank account, and then you don't have to worry about it. You could also work with a traditional financial advisor, but that will cost more. And then if you want to do it yourself, you know, there's all kinds of research. You can do stock investing. You can use mutual funds or

index funds. There's lots of options. And we have lots of information on how to do that on nerdwallet.com. But that's really the how of how you do this. I want to go back to a term that we've mentioned a couple of times so far, and that's taxed advantaged. And Alana, can you explain how that pertains to 401ks, Roths and the like, and why it's such a big deal? So tax advantaged is just a fancy word for you get a nice tax benefit, which is a good thing. You should be excited about any kind of tax benefit because most likely it will equate to more money in your pocket. So traditional 401ks and IRAs, you can say, hey, I contributed this amount of money and so you'll get a nice tax break up front. But Roth accounts, so either a Roth 401k or a Roth IRA, they don't

offer an upfront tax deduction, but you get to take your money out tax-free in retirement. So you put it in after you've already paid taxes on it, and then that money grows tax-free for many, many years. So a lot of people find Roth accounts more attractive for that delayed benefit, but it will depend on you and your individual tax circumstance. But again, this is why you might move from a 401k if it's a traditional one to an Roth IRA. It's because of that really healthy tax benefit. Okay, so in

contrast to tax advantaged investment accounts, like certain kinds of retirement accounts, there are also taxable brokerage accounts too. And those are either offered by traditional brokerages or banks or robo-advisors. And they don't have the special tax treatment, right? How are they taxed? Again, we just want to clarify some terms. And I'm really, really glad you asked this question because these things can often get conflated, which is why I'm so adamant about the what, the where, and the how. Robo-advisors may be able to be tax-advantaged if you use them in the right account. So again, robo-advisors, that's how your investments are going to be managed. Many robo-advisors offer retirement accounts like IRAs, but not 401ks since those are offered through your employer. But if you open a taxable

account through a robo-advisor, yes, it won't have those tax benefits. But if you open a Roth IRA and you're having it managed by a robo-advisor, then you will be able to get the tax benefits. So again, it's not about who is furnishing the account, but it's about the type of account that you have. Exactly. And that's why it's so important to pay attention to your account. A lot of people, they might start up with a robo-advisor, don't have the background information, and the robo-advisor maybe would put them into a taxable brokerage account, but maybe they'd prefer to be in a retirement account. So it's important to kind of have that background, even heading into something like investing with a robo-advisor,

so you know exactly what you're getting yourself into. All right. So all that being said, let's go back to how these accounts are taxed. If you're looking at a taxable brokerage account for investing purposes, what sorts of taxes do you need to just be aware of when you're making investment decisions? Yes, this is the joy of long-term versus short-term capital gains taxes, which are taxes, so we aren't huge fans of them. But if you are investing and you are making money, there will come a day where you need to pay taxes on the profits that you make from selling your investment. So you hold an investment for a long time. Hopefully you make a bunch of money off of it. That money, you might need to pay some form of

capital gains tax. If you've held onto an investment for more than a year, you're going to pay what's called long-term capital gains tax. And that tax rate can be 0%, 15%, or 20% depending on a couple factors like your taxable income and your filing status. In contrast to that, if you hold onto an investment for one year or less, you'll have to pay short-term capital gains, which are taxed at your ordinary income tax rate or your tax bracket. And the end takeaway of all of this is that long-term capital gains are likely more advantageous for you. And so if you can hold onto investments for longer than a year, you'll be taxed at a better rate. Good thing to keep in mind for anybody who is thinking about the taxation of their investments. And Amy, in their question, mentioned a concern about the tax efficiency of their retirement investments. So it sounds like in their case, the 401k and

Roth strategy combined could be an option for them. But let's turn to different investment options within all of these different kinds of investment accounts that we've talked about so far. How feasible or common is investing in an ETF or exchange traded fund or an index fund through your 401k? And maybe we should also start by defining those terms for our listeners who might be unfamiliar with them. I think that's a great idea. ETFs are funds. So funds are basically baskets of investments. It's a whole bunch of stocks all stuffed into one investment that you buy all at once versus buying a single individual stock. Exchange traded funds are a type of funds as are index funds or index mutual funds. And a couple of different things are important here. So

whether or not you're actually able to pick your own investments as specifically as exchange traded funds or index funds is going to depend on your specific 401k plan. So that's something that you'll need to ask your 401k provider about. But a lot of 401ks will actually set you up with what's called a target date fund. Target date funds are really interesting because they automatically adjust your allocation over time. So if you start investing when you're 20, your target date fund will likely have a riskier group of investments held within it. And as you get closer to your target date of retirement, which is why they're called that, your allocation will shift to be more conservative over time. And that'll just happen in the background. That's what most 401ks are made up of. So going in and changing what you're investing in in a 401k is pretty rare. You'll likely just be in the investment in a target date fund that is selected for you by your 401k provider. Well, just to get to the core of our listeners question and ask it straight out,

are exchange traded funds or ETFs a better quote unquote choice for retirement investing versus index funds since ETFs are more tax efficient? Yes. So ETFs technically are more tax efficient than index funds just because of how they're structured. When you sell an ETF, you're typically selling it to another investor who's buying it and the cash is coming directly from them and then you have to pay capital gains taxes. But it's a little bit different with an index fund. And the long story short is that you could potentially owe capital gains taxes

without actually selling a share because of how they're structured. That being said, this happens a lot less frequently with index funds and ETFs than it does with other types of mutual funds. And from a tax perspective, ETFs generally have the upper hand over index funds, that's true, But it's a pretty minute difference. And you probably will not have a huge tax bill just because you invested in an index fund versus an ETF. So if you have the option, maybe go with an ETF. If you don't, I really don't think you should be too stressed out about it. Okay. But in general, if you are investing for retirement through a

retirement account like a Roth IRA or 401k, the ETF versus index fund question probably isn't that big of a concern since you most likely are not actively buying and selling stocks within these accounts, right? I'd say that's true. And I think also to get to the listener's question is that she's talking about potentially doing this through a 401k. Again, I'd stress like it's fairly unlikely that you can actually do that unless your 401k provider allows you to do that. you said, through a Roth IRA where you have to pick your investments yourself, again, unless you are using a robo-advisor in which the robo-advisor would pick investments for you. And most of the time, robo-advisors invest you in a handful of ETFs and index funds as well. So you'll be in kind of the same investments no matter what. So it kind of sounds like what's worth losing sleep over isn't necessarily these decisions that don't have massive differences

between them, but more so just getting started on investing for retirement in the first place whenever you're able to, and consistently setting money aside for retirement over time and just letting those investments hopefully grow. Exactly. So everybody, save for retirement if you can. Anyway, Alana, is there anything else folks should keep in mind when deciding where and how to invest for retirement? I think you really said it. Keep in mind that the importance of account types should not be

understated. So don't just open a standard brokerage account if you think you could benefit from the tax advantages of something like a Roth IRA. Really make sure you know what type of account you want to get into and then start worrying about what types of investments you want to get into. Well, Alana, thank you for joining us. Thank you for having me. And now let's get on to our takeaway tips. Sarah, will you please kick us off? Of course. First, understand how accounts are taxed. Roth IRAs, 401ks,

and other retirement accounts are taxed more favorably than brokerage accounts. Next up, consider different investment options. Once you have your retirement account, you have a number of choices like target date funds or mutual funds. And finally, investments have their tax differences too. ETFs are more tax efficient than index funds, but the difference is fairly small and it's not typically a major factor in retirement accounts. And that is all we have for this episode. Do you have a money question of your own? Turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD. You can also email us at podcast at nerdwallet.com. Visit nerdwallet.com slash podcast for more info on this episode. And remember to follow, rate, and review us wherever

you're getting this podcast. And here's our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. This episode was produced by myself with help from Liz Weston. We had fact-checking help from Pamela De La Fuente. Kaylee Monaghan mixed our audio. Jay Bratton wrote our show notes. And a big thank you to the folks on the NerdWallet copy desk for all their help. And with that said, until next time, turn to the nerds!