Financial Life Advisor

When to File - Understanding and Maximizing Social Security Benefits part 2 of 3

There is a common perception that as soon as someone is eligible for Social Security benefits, they should file for them. The general public has often questioned whether or not Social Security benefits will be around in the future, so the thought process is that you better collect benefit while they are still there. I believe the answer is not quite that simple. It would be politically unpopular to end Social Security; a much more likely case is to increase taxes, lower benefits, or increase retirement ages. It could be a combination of those factors, but most likely, as in the past, benefit reductions (if implemented at all) will affect much younger workers who are years away from retirement.

Early or Late? Which pays the most benefits?

In fact, for the average American, the value of taking Social Security retirement benefits early or late are equal. What I mean when I say equal is that based on an average life expectancy, the total value of receiving a lower benefit for a longer period of time is equal to the value of receiving a larger benefit for a shorter time.

The “break even” age is somewhere near 80 years old depending on the assumptions used. Coincidentally, this is approximately the age the average retiree will live to. By this standard, if a retiree lives longer than 80, they would have received the most benefit by delaying retirement until the latest date possible (age 70). If they are going to die in their early 70’s, they should file as early as possible to maximize their benefits. Of course it is impossible to know exactly how long you will live, and even with a certain life expectancy, there could be restrictions or other reasons why an early or late retirement would make sense in a particular situation.

Reduction & Taxation of Social Security Benefits

For instance, let us say your family has a history of dying young. It would make sense that filing for Social Security benefits as soon as possible is your best course of action.   You get to age 62 and go file for benefits. You enjoy your job and can’t really afford to retire at 62 anyway, but you figure the extra money will be nice.

You soon discover that while you are working, your Social Security benefits can actually be reduced and even eliminated by earned income. In 2010, there is a $1 deduction for every $2 of income above $14,160. Even with an income of $40,000 per year, the maximum age 62 benefit in 2010 would be wiped out completely.   In the year of NRA, the earnings limits are higher and the reduction calculation is lower, but the concept is still the same.   The good news is that if someone files early and then has their benefits reduced because of earned income; Social Security will go back and recalculate the benefit as if they had not filed early. Therefore, there is no real penalty for filing early except for the possible surprise that those benefits which were paid during the year have to be paid back.

Once a retiree reaches their Normal (Full) Retirement Age (NRA), there is no reduction in benefits. A retiree can earn as much money as they want without a loss of Social Security benefits.   Income levels can affect the taxability of Social Security benefits after reaching NRA.   Depending on filing status (single or joint), up to 85% of Social Security benefits will count as income for Federal tax purposes. Unlike the reduction of benefits prior to NRA where only earned income is considered, after NRA Social Security benefits are taxed based upon taxable income. Taxable income includes all types of income including interest and dividend income. To clarify, passive sources of income are not considered earned income (relevant before NRA) for Social Security purposes.

Strategies for Filing

If you are single when deciding when to take Social Security benefits, the decision is relatively easy. You look at your potential life expectancy and/or decide if you want longevity insurance by delaying benefits. When you are married, you have many more options and considerations when deciding on a strategy to maximize benefits.

There are several key concepts which need to be understood when thinking about Social Security maximization strategies:

     -When a retiree claims worker or spousal benefits early, reductions to those benefits are permanent. (Unless paid back, discussed later)

     -Spousal benefits can be reduced for early retirement but do not increase past NRA.

     -Spousal benefits can only be claimed if the spouse whose record is being used has already filed for retirement benefits.

     -Spousal and work benefits do not have to be claimed at the same time. It is the default assumption that when filing for benefits, both types are being applied for at the same time. When both benefits are applied for, the worker’s benefit is paid first, and the spousal benefit is only paid on the portion which is greater than the worker’s benefit.

     -Window(er) benefits are paid to the surviving spouse and equate to the higher of the two spouse’s benefits. If the surviving spouse takes survivor’s benefits prior, to NRA there is a reduction.

Couples who file for Social Security benefits have many more considerations and options when deciding on a filing strategy. The respective ages of each spouse, each spouse’s own benefit levels, and overall health and life expectancy play major roles in the decision making process. Because the complex rules of Social Security can make some strategies work for one couple it does not mean the same strategy would work for another couple.   There is no one size fits all Social Security strategy.

Higher Earner Waiting Until Age 70

It is often a good strategy for the higher wage earner to wait until age 70 to file for their own Social Security benefits. The main reason for this is that when you are dealing with a couple, their combined life expectancy is almost always higher than the average life expectancy of one person. Since the “break-even” point for filing early vs. late is about 80, the likelihood one of the two spouses will living past 80 is fairly good. By the higher earning spouse waiting, the survivor gets the highest single benefit possible.

The advantage of waiting until age 70 to file becomes especially attractive if there is a significant age difference between the spouses. A surviving spouse who is at NRA can receive the full delayed benefit of the deceased spouse. You could have a high earning husband who delayed filing until age 70 and then passed away at 77 with a spouse who is 10 years younger (67) and that spouse would receive the age 70 benefits for the rest of her life.

Conclusion

There are too many options to produce a silver bullet on one filing strategy. In my experience, it is almost always best for the higher earning spouse to delay taking their own worker’s benefit until age 70. This provides for the most protection to both spouses in the long term. The question, then, is when should the lower earning spouse file, and for what types of benefits?

This is where reviewing those key concepts discussed above need to be considered. The best way I have found is to lay out the potential monthly payments available at 62, NRA, and 70 for the lower earning spouse for both worker’s and spousal benefits. Keep in mind that spousal benefits may not be available at 62 or even 66 because the worker’s record from which those are derived must have filed.  

There is another option that has not been discussed yet. It is possible to file for Social Security benefits and then repay and reset. Find out more about the “do-over” available in Social Security in the final segment of this series “Repaying Social Security & Special Rules - Understanding and Maximizing Social Security Benefits part 3 of 3”. If you or your spouse qualify for a government pension, special rules may reduce or eliminate Social Security eligibility. So find out how those rules may affect Social Security benefits.

For more information go to www.ssa.gov

If you missed part 1 of this series you can find it here:
“The Basics of Social Security – Understanding and Maximizing Social Security Benefits part 1 of 3”

Posted by Ben Gurwitz on 15th February, 2010 | Comments (1) | Trackbacks
Tags: Financial Planning, Social Security, Retirement Planning, Feb 10

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