Will current, or soon to be, retirees lose their Social Security benefits? I think 55 million retirees will vote out of office any politician who supports stopping Social Security. Rather than discussing losing Social Security, let’s focus on “Getting More from Social Security” by making the “right” decisions. Most people give little thought to Social Security decisions like when to start, maximizing spousal benefits, integrating with other retirement income, how benefits are taxed and using Social Security rules to their advantage.
The typical retiree says: “I’m retiring and I’m taking my Social Security before it stops”. Local Social Security offices give no advice on how you can maximize your family’s lifetime benefits. That’s why over 70% of current Social Security recipients got it “wrong” and each will lose tens of thousands of dollars in lifetime benefits. You have only one chance to get Social Security right, so how’s that done if you’ve not started Social Security and how do you keep more of your benefits if you have?
Unless disabled or your spouse has died, the earliest age you can start Social Security is 62. If less than full retirement age and still working, Social Security benefits will be reduced up to $1 for every $2 you make over $12,640 a year – this is the 2012 level but can change annually. Full retirement age for Social Security is 66 if born between 1943 and 1954. Since Social Security is a lifetime benefit starting younger (early) means a smaller check and starting older (postponing) a bigger check. Benefits grow at an annual rate of about 7% for each month delayed from age 62 to 66 and at an annual rate of 8% if delayed from full retirement age to 70. No growth is given for delaying beyond age 70. If you qualify for $12,000 at age 62 delaying until 66 will raise annual benefits to $16,000 and delaying to age 70 raises benefits to $22,000. Benefits are increased yearly if there has been inflation.
Social Security benefits are never fully taxed by the federal government and most states; thus, it pays to delay and get a bigger check that is only partially taxed. If you are married your spouse is entitled to receive the greater of: (1) benefits based on their own work record or (2) 50% of what you’re entitled to receive at normal retirement age. If a dependent spouse starts Social Security before reaching full retirement age two bad things happen: first, their benefits are reduced for starting early; second, they cannot later switch to benefits based on their own work record. If a dependent start benefits after reaching full retirement age, both these bad things disappear. If you are married, healthy and can afford it, delaying Social Security is probably the best retirement move you can make because your family’s lifetime income will be thousands of dollars higher.
Here’s an example of a typical married couple: Mary and John, both age 66, recently retired, enjoy good health and have ample retirement savings to do without Social Security for a few years. Mary qualifies for $15,000 annual Social Security and John is entitled to $16,000. What should they do?
Most retiring couples would start Social Security and take the $31,000 annually. Odds say Mary will outlive John by at least six years because females live longer. So instead of taking the $31,000, I’d recommend the following:
- Mary file for Social Security and start drawing $15,000 a year;
- John files as Mary’s dependent and draw $7,500 a year – 50% of Mary’s benefits: since John is at full retirement age he can postpone and later switch to benefits based on his own work record;
- John postpones until age 70 and will get $22,000: combined they’ll get $37,000.
- If John dies first, Mary’s benefits increase to $22,000 for the rest of her life.
Bear in mind that Social Security is increased yearly for inflation – the numbers I used did not account for the annual inflationary Cost of Living Adjustment.
If you assume 3% annual inflation, Mary and John’s annual benefits are over $6,000 a year higher starting at age 70 and reach a positive difference of over $10,000 a year at age 86 (and continue to grow the longer they live). If Mary and John live to their life expectancy their lifetime income from Social Security will be over $200,000 higher because Mary delayed benefits until full retirement age and John delayed until age 70. Plus Mary has more late-in-life financial protection when she needs it most – she can be John’s caregiver, but for her it could be a nursing home and the extra Social Security could make a big difference. Where else can you get 8% growth backed by a government promise, inflation protection, tax-favored income with comparable spousal benefits?
Another example is a married couple Bill and Jane. Bill just turned 66 and wants to continue working whereas Jane, age 62, does not qualify for Social Security as she did not work outside the home. At 62 Jane is eligible for dependent benefits but cannot qualify unless Bill starts Social Security. Bill could start his Social Security without suffering the working penalty since he’s at full retirement age, but since Jane is younger he’d like to assure her larger benefits by delaying. What can they do?
Since Bill has reached full retirement age he can file for Social Security and suspend. If Bill’s benefits would be $16,000, Jane’s dependent benefits would be $6,000 – only about 37.5% of Bill’s rather than the usual 50% because Jane started early at age 62. Bill plans to postpone until age 70 to get maximum growth and to provide Jane more financial security if he dies first as expected.
Another example, let’s say Paul age 63 was just laid off at work and needs his Social Security. He filed and started receiving Social Security but within a year he was called back to work. If Paul works while getting Social Security his benefits will be reduced because he’s less than full retirement age. He can do without Social Security now that he’s working again. What can Paul do? During the first year of receiving SS benefits you can change your mind, pay back to Social Security without interest the money your family received and start again later at higher benefits. Up until recently you could change your mind anytime after starting Social Security, pay back the money without interest and start over at higher benefits. This loophole was closed in December 2010.
If you and your spouse are now getting Social Security but paying taxes on the benefits what can you do? If you have earnings that are not needed but are reported as income, for example interest on bank CDs or bonds, why not defer the income and reduce taxes on your Social Security? You can defer taxes with an annuity, convert to a tax-free Roth IRA or use several other safe strategies your financial advisor can tell you about. Taxes on Social Security can be reduced without taking risks and without losing control of your money. Remember, a dollar not paid in taxes is another dollar to enjoy in retirement.
Let say you and your spouse got Social Security “right” and will enjoy an extra $200,000 in lifetime income; however, the Social Security benefits you receive, say $35,000 annually, will not be enough. You’ll need $50,000 a year in “constant inflation adjusted dollars” for the retirement you’ve planned. You have other assets – stocks, bonds, real estate, mutual funds, variable annuities – but all have one thing in common: risk of loss. You’d like an additional $15,000 guaranteed yearly income (inflation adjusted) to be paid regardless of future interest rates or market gyrations. What can you do?
Outliving your money is called Longevity Risk and is the greatest fear of most retirees. What do you do when faced with risk too big to assume: your home being destroyed, car wrecked, serious illness, premature death or other catastrophic loss? You pay an insurance company to manage the risk by spreading it over thousands of policyholders. The small premiums paid are a great value for the peace of mind received. Insurance companies offer Longevity Insurance that guarantees a lifetime income and unlike health or life insurance there are no medical or health limitations. The guaranteed lifetime income is a feature of certain tax-deferred annuities that your financial advisor can tell you about. The $15,000 Social Security supplemental income, adjusted for inflation, is easy to get plus you’ll have flexibility in case you change your mind and want your money back rather than taking a guaranteed lifetime income.
We’ve only explored some of the dark corners of the Social Security maze – I encourage you learn more on your own at www.ssa.gov or meet with your financial advisor about getting your Social Security “right”. If you haven’t yet start Social Security, or started in the last year, you have time to make the right decisions. If you’ve already started Social Security you should focus on reducing taxes on the benefits and “locking up” a Social Security supplemental income if outliving your money is a concern.
Shelby J. Smith, Ph.D.
June 2012
