Last year, one of our Newsletter articles discussed some of the basics about claiming Social Security benefits. Because we get so many questions from clients about Social Security, we thought it might be helpful to revisit this topic and further elaborate upon some of the strategies you might be able to use to help maximize your retirement benefits.
First, however, you need to understand how your Social Security benefits will be calculated. According to the Social Security Administration (SSA):
“Social Security benefits are based on your lifetime earnings. Your actual earnings are adjusted or “indexed” to account for changes in average wages since the year the earnings were received. Then Social Security calculates your average indexed monthly earnings during the 35 years in which you earned the most. We apply a formula to these earnings and arrive at your basic benefit, or “primary insurance amount” (PIA). This is how much you would receive at your full retirement —age 65 or older, depending on your date of birth.”
It is important to note that your 35 highest earning years need not be consecutive. Also, you do not need to specifically identify for the SSA which are your highest earning years. Rather, the SSA will automatically do this. However, it is wise to periodically check your earnings history as recorded by the SSA to confirm they have a correct record of your earnings.
If you do not have at least 35 wage earning years, you are still entitled to receive Social Security benefits – however, your benefits will likely be less than if you had worked at least 35 years. Your benefits will be lower because you will have some zero earning years included in your 35 highest wage earning years calculation. You can alleviate this situation by continuing to work or returning to work. This way, you will have more wage earning years to add to your benefits calculation and fewer zero earnings years left to drag down your benefits level.
Second, you need to understand how the timing of when you begin to take your Social Security benefits could impact the amount of benefits you will receive during your lifetime and possibly that of your spouse as well. You will have the opportunity to begin taking your Social Security benefits as early as age 62. However, you will also have the choice to defer taking your benefits until you reach your full retirement age (between ages 65 and 67 depending upon when you were born) or until you reach age 70. If you opt to begin taking your benefits before you reach your full retirement age, you will receive a monthly benefit amount that is about 75% - 80% of what you would be eligible to receive each month if you waited until you reached your full retirement age. Similarly, if you put off taking Social Security benefits until after you reach your full retirement age, you will increase your full retirement age benefits by about 8% for each year you defer up to age 70. Thus, if your full retirement age is 67 and you defer your benefits until age 70, your benefit amount will be about 124% of what your benefit would have been had you retired at age 67. Please note that additional benefits accrue only up to age 70 so there is no reason to defer beyond this age limit. In addition to larger monthly benefits that come from deferral, it is also worth noting that annual cost-of-living increases will be larger, in dollar terms, as well. The compounding impact of this should not be underestimated!
About half of all retirees in the US choose to take their Social Security benefits as soon as they are able (at age 62). For some of these folks – particularly those in poor health and those who are short of funds – taking their Social Security benefits at the earliest possible date probably makes the most sense. For many others, however, it makes more sense, financially, to wait at least until full retirement age, or longer, to begin taking benefits.
It may seem counter-intuitive to defer taking your Social Security benefits. Why not collect a slightly lower amount as soon as you can and for as long as you can? Why chance it that you may not live as long as you may think or that Social Security may scale back benefits? If you start taking your benefits at age 62 at least you know you will collect something.
While these arguments may sound good, the reality is that many Americans will live well into their 80’s and even 90’s (US life expectancy is currently 78.1 years; e.g. 50% of the population will live longer than that). According to the US Census Bureau, those aged 85 and older are the fastest growing elderly age group. Also, in the age 85 and older category, women outnumber men by 5 to 2. Many of these women have been widowed. By 2050, the Census Bureau predicts that one of every five Americans will be classified as elderly. In other words, life expectancies continue to increase and as a result, personal financial planning needs to include the growing possibility that individuals could easily live to be 90, 95, or older.
When you begin to consider the very real possibility that you and/or your spouse could very well be alive for many years after you begin taking your Social Security benefits it may make sense to defer accessing your benefits until you reach full retirement age or even up to age 70. There are several reasons for this and a simple example illustrates why:
Example #1: You are scheduled to receive $1600/month in Social Security benefits if you retire at aged 62. If you wait until your full retirement age, you will receive $2000/month. Finally, if you wait until age 70 you will receive $2600/month. If you are now age 62 and you die at age 85, this is how you will fare depending upon
when you start taking your Social Security benefits –
- Age 62 = $414,000 in lifetime SS benefits (1500x12x23)
- Age 67 =$432,000 in lifetime SS benefits (2000x12x18)
- Age 70 =$468,000 in lifetime SS benefits (2600x12x15)
And this simple example ignore cost-of-living increases!
As you can see, in this instance, it makes better financial sense to defer taking your benefits. And, the longer you live the more sense it makes. If you live to age 95, you would receive $780,000 in benefits if you waited until age 70 but only $594,000 if began taking your benefits at age 62. Of course, the opposite is also true. If you die at age 75, you are far better off having chosen to take your benefits at age 62 – you will receive $234,000 in lifetime benefits versus just $156,000 if you waited until age 70 to begin collecting your benefits.
Things can get even more complicated if you have a spouse. There are ways spouses can work together in order to maximize their joint Social Security benefits. For example, a spouse is entitled to receive a spousal benefit even if he or she never earned any wages. The spousal benefit amount generally equals one-half of the working spouse’s full retirement benefit assuming the non-working spouse waits until full retirement age to begin taking the benefit. If the spouse claims the spousal benefit prior to reaching his or her full retirement age the amount will be reduced accordingly. If a spouse did earn wages, he or she is entitled to receive the greater of either the spousal benefit or his or her own benefit amount. In other words, if spouse A is entitled to receive $1000/month at full retirement age and ½ of spouse B’s benefit is $1400, then spouse A is entitled to receive $1400/month.
Taking the concept of the spousal benefit one step further, two working spouses can use the spousal benefit as an interim source of income thereby enabling a spouse to defer his or her Social Security benefits until age 70 and thus locking in the highest monthly benefit. For example, if a husband and wife both work and the wife has been the higher wage earner, at full retirement age she can elect to take her spousal benefit (1/2 of her husband’s full retirement benefit amount). He can also elect to take his own benefit amount and he need not wait until he reaches full retirement age. However, if he opts to take his benefit amount early, it will be reduced accordingly. Then, at age 70, the wife opts to take her Social Security benefits based upon her own earnings history. Because she waited until age 70 she gets a larger amount than if she had taken her benefits at her full retirement age. This kind of strategic planning allows spouses to increase the amount of money they can take out of Social Security and still preserves their ability to have at least one spouse (usually the larger wage earner) wait until age 70 to claim his or her benefits.
In the case of a widowed spouse, he or she will still receive Social Security benefits – the greater of either the benefit based upon the widowed spouse’s own earnings or the benefit based upon the deceased spouse’s earnings. It is important to note, though, that the maximum a widower can receive based upon a deceased spouse’s Social Security benefits is that which the deceased spouse would receive if he or she was still alive. In other words, if a husband elects to take his Social Security benefits starting at age 62, he locks in a monthly benefit amount that is lower than what he would have received had he waited until full retirement age. When he dies, his widow is then held to this lower benefit amount even if she is of full retirement age. As you can see from Example #1 above, the decision to take benefits at age 62 ($1500/month) versus age 70 ($2600/month) can have a far-reaching impact on a widowed spouse.
As you have probably gathered from this article, there are a number of variables to consider when deciding how and when to take your Social Security benefits. The examples presented here are just a few fairly simple scenarios intended to illustrate some general planning concepts and pitfalls. If you would like to discuss your personal situation or to assess what strategies might make the best sense for your family, please do not hesitate to contact your investment advisor here at BLBB. It is important that you fully evaluate your options before you start to receive benefits!