If you’re like most people, you are probably looking forward to retiring and living as long and as comfortably as possible. As you plan for retirement, however, concern can creep in regarding how long your money will last. That’s why Social Security may be a bigger piece of your retirement puzzle than you previously thought.
Social Security benefits act as a buffer against inflation and the risks involved with investing and living into old age. Along with pensions and income annuities, Social Security is a source of guaranteed, stable income that lasts a lifetime. The benefit is adjusted annually for inflation and also provides benefits for spouses and survivors.
As you plan for retirement, it’s essential to recognize the role Social Security benefits play in your future income and how you can maximize your benefits by making informed financial decisions that are right for you and your family.
The first decision you want to make is when to start taking your Social Security benefits. Timing your Social Security benefits may be the most important retirement decision you can make, but what exactly factors into this timing? Let’s begin with the basic types of benefits for retired workers who have contributed to Social Security for at least ten years. Retired workers have three options for deciding when to begin collecting benefits: before, at, or after full retirement age (FRA).
Individuals who decide to begin taking benefits at FRA receive 100% of their Social Security benefits or primary insurance amount (PIA). Individuals who decide to apply for benefits after FRA, earn 8% in delayed retirement credits (DRC) for each year they choose to delay, until age 70. This means that by waiting until age 70, some retirees may be able to increase their PIA by as much as 32%—8% each year for four years of delayed payments from FRA 66 to 70. Individuals who take Social Security benefits before the designated FRA will receive reduced benefits. Age 62 is the earliest an individual can start taking retirement benefits. However, someone that begins taking benefits at age 62 can expect to have his or her PIA reduced by 25% for life (assuming an FRA of 66 today). The chart below shows FRA for various birth years:
While eligibility for benefits is based on 10 years of working, benefits are calculated based on the average of your top thirty-five wage-earning years. If you did not work for thirty-five years, zero is entered into your equation for each year there are no earnings. Cost-of-living adjustments will automatically increase your benefit each year based on an inflation percentage determined by the Social Security Administration (SSA). For 2015, the increase was 1.7%. There is a maximum amount of Social Security income you can receive each year. In 2015, the maximum benefit at FRA was $2,663 per month. Delaying your benefit to after your FRA will increase this amount.
The decision on when to begin receiving Social Security benefits for many people is as simple as selecting a retirement age of 62, 66, or 70. The answer depends typically on the following factors:
1. Your lifestyle goals and detailed budget for retirement
2. Your current savings, investments and earnings to help achieve your goals
3. Your health and expected longevity
4. Your current and past marital status
5. Your continued earning power and interest in working after age 62, until or after FRA or until age 70
There are many more factors that can affect your decision, but planners usually focus on the above mentioned. The purpose of this article is not to help you make a decision about when to collect, but to make you aware of various peculiarities of Social Security when calculating benefits that most individuals are unaware of.
Generally, here’s how your benefit is determined when deciding at what age to start collection. The SSA will determine your full benefit at your FRA. This amount is determined by your lifetime earnings history. As I mentioned, if you choose to take your Social Security at age 62, your benefit will be reduced by 25%, permanently. However, if you delay until age 70, your benefit will be 76% higher each month than if you start at age 62 as a result of the DRC.
So, everyone’s strategy should be to wait until age 70, right? Not necessarily. Most people are unaware of a spousal benefit. Let’s assume both spouses expect an annual benefit at FRA 66 of $25,000 per year (this amount would increase by 32% by age 70). Even though they’re both waiting until age 70 to collect, they should both file and do a restricted application to postpone earned benefits. Then one spouse should file for spousal benefits which will pay one half of the other spouse’s monthly benefit from age 66 to 70. The SSA will have paid one spouse $50,000 ($12,500 annually for 4 years) just for employing this strategy, which in no way affects their own age 70 benefits.
Remember, mortality has a lot to do with what strategies to employ. Let’s look at another example. I have a client who is age 62. He decided to take his retirement early at age 62 because:
1. He’s a recent organ transplant recipient and doesn’t expect to reach expected mortality and
2. He has a minor child that is 17 years old.
Due to the fact that she is a minor and a full-time student, by starting his Social Security benefits at age 62, the SSA will increase his monthly payout by about $1,000 until his daughter reaches age 19. In his case that’s $24,000 more than he would have received if waiting until his FRA (age 66).
These are just two examples where effective planning and knowledge of Social Security benefit rules can help retirees potentially enhance their lifetime Social Security benefits. Every individual and married couple has a different set of work experiences, financial assets, and life expectancy so Social Security benefit outcomes can vary significantly. Because of this, everyone needs to have a plan suited to their personal needs.
As illustrated above, Social Security not only provides retirement benefits for individuals, their spouses, and minor children, but these benefits as well:
• Spousal benefits for those caring for an eligible child or children
• Child benefits for disabled children of retirees, regardless of the child’s age
• Divorcee spousal benefits
• Survivor benefits
A special note regarding some divorced individuals who can also take advantage of these strategies. In addition to their own benefit, a divorced spouse may be able to claim spousal benefits if she or he were married for at least ten years, has been divorced for at least two years and is currently unmarried. However, unlike traditional spousal benefits, the former spouse does not need to file for retirement, they just need to be eligible (i.e. age 62). This strategy generally works best if the former spouse’s earnings record was higher.
Utilizing this strategy will allow the divorced spouse who satisfies the claiming rules to take spousal benefits from the former spouse at FRA and then switch to their own benefits at age 70. To do this, the divorced spouse should notify the SSA that they are filing a restricted application for spousal benefits.
Deciding when to begin taking Social Security is a personal decision that can be challenging and complex. But employing basic, informed strategies can easily maximize one’s lifetime payout. The examples given above were merely for illustration purposes. Every situation, fact, and circumstance is different. Consulting a tax or Social Security planning advisor can help determine the course best suited for you.