by Steve Goodman
CPA, MBA – President & Chief Executive Officer
Contact Steve today for more info.
Social Security was signed into law in 1935 to become America’s retirement program of last resort. The original program was an annuity program based on the demographics of the time. Since its founding, the program has been enhanced and modified several times. The country’s demographics have changed. What was once a relatively simple and basic program became complicated. Congress eliminated some of the complexity in its 2015 Social Security bill. For those well positioned, this Congressional adjustment eliminated many of their options to benefit from the prior rules. For others, it forced some difficult choices for people with few options.
Social Security was intended to be a small portion of people’s retirement income. Yet an estimate offered by the chief author of a recent National Bureau of Economic Research notes that Social Security is the most important contributor to 85% of Americans retirement income. And he notes that the estimate may be too low. Social Security is a meaningful government program in most Americans lives.
The government began indexing Social Security payments for inflation in 1972. The government employs the CPI-W measure to determine changes in the rate of inflation. CPI-W measures inflation for urban workers. CPI-W understates the percentage of medical expenses and housing costs incurred by most older Americans in their budgets. The Senior Citizens League estimates that the difference has lead to a shortfall in real income of 30% for Social Security recipients since 2000. No cost of living adjustments was issued in January 2010, 2011 or 2016 based on a calculated zero or negative growth in inflation in the prior years Q3 over Q3 cost of living.
One of the proposals floated for resolving the pending imbalance between Social Security inflows and outflows substitutes chained CPI for CPI-W. Chained CPI assumes that people trade down in product quality due to price increases. As an example, high prices for beef sirloin result in people buying more chuck. Under chained CPI, these downgrades in lifestyle result in reduced costs thereby reducing the calculated inflation rate.
Qualifying for Social Security
Before one is provided the opportunity to choose a start date, one must qualify for social security. Not every American is covered under the social security system. Federal and many state workers are covered under retirement programs that do not include Social Security.
The following factors are used to determine to qualify:
- Earnings History – how much did you make and paid into the Social Security system.
- Work History – How many years did you contribute to the Social Security system. Social Security uses your 35 highest earning years, adjusted for inflation and a maximum earnings cap, to determine your base payout level.
- When You Were Born – You must be at least 62 to begin collecting Social Security on your own account.
Assuming you are eligible to collect Social Security benefits based on your work history and age, the next choice is when to begin collecting.
Your work history identifies the dollar amount of monthly benefit available to you when you reach your Full Retirement Age (FRA – see below). This poorly named term is the middle of three key dates for social security participants.
- 70 is the last age for people who choose to maximize their benefits. If you begin your benefits anytime between your FRA and the month you turn 70, your base amount is increased at an 8% annual rate for each month delayed beyond your FRA. The 8% annual increase ends at 70, so there is no benefit to delaying beyond 70.
- FRA used to be your 65th birthday. It is now a variable date for those born in 1951 or later that begins at age 66 and varies by month until age 67 for those born in 1960 or later. At this date, you can receive the amount that the Social Security Administration (SSA) identifies on your benefit statement.
- Age 62 is the earliest you can begin collecting. There is a penalty imposed for collecting early. You will be penalized 5/9th of 1% for the first 36 months you begin to collect prior to FRA. If you start collecting more than 36 months prior to FRA, then the penalty increases by 5/12th of 1% for each additional month.
The difference between collecting at age 62 and age 70 ranges between 70% and 75% depending upon the year of birth. The difference in benefit level can be significant if the person lives a longer than average lifespan.
The penalty and bonus payments are designed to create break-even comparisons that make sense for the average person. We define the break-even age between two alternative courses of action as being an age at which the simple sum of all benefits paid from the two choices is the same. The break-even calculation does not consider the opportunity cost of receiving funds at an earlier age nor does it include any Social Security cost of living adjustments. Consider a choice between collecting at age 62 or waiting until FRA at 66 years old. The two revenue streams will yield equal payments at age 77 to 78. Comparing 62 to 70, the break-even age is roughly 80 to 81. The difference between FRA and age 70 is the break-even age of 82 to 83.
The right personal choice is a function of alternative income sources, work status, other Social Security-related matters, and life expectancy. Other Social Security matters may include the immediate need for collecting spousal benefits for an informed spouse. Social Security offers people a range of options. This allows people to choose wisely or poorly from among the options.
There are taxation issues that a potential retiree needs to consider. At the federal level, if one begins receiving benefits while still working and having yet to achieve FRA, then the government may withhold benefits. If our recipient will not reach FRA in calendar 2018 and earns more than $17,040 in 2018, SSA will withhold $1 for every $2 it was scheduled to pay out. If our recipient will achieve FRA in calendar 2018, and our recipient earns more than $45,360 in 2018, then SSA will withhold $1 for every $3 it was scheduled to pay out.
The implied cost of money in this situation is very steep. In the first case, where one is losing 50% of the benefit, not only is the person immediately losing half the payout but also being penalized at least 5/9th of 1% per month for each month before FRA. If we assume our example recipient was scheduled to collect $800/month. He/she loses $400 to the penalty. He also would have collected at least $57/month more had he waited one year to start collecting.
The second federal concern is federal taxes. A single person is taxed on 50% of his/her benefits if he/she earns more than $25,000 in Adjusted Gross Income (AGI). For a married couple, the threshold is $32,000.If a single person has an AGI over $34,000 or a couple has an AGI in excess of $44,000, then 85% of the Social Security benefit is federally taxable.
On a state level, there are 13 states that may tax your social security benefits. Each state has its own policies regarding income provisions, so you may want to check with your current state and anywhere you may be planning to consider for retirement.
Basic Optimization Strategies
For relatively healthy, single people with no dependents, the rule of thumb is simple – delay collecting until age 70. Once you achieve age 82 or 83, you will have caught up with the funds you would have received had you began collecting at FRA. This calculation does not include the opportunity lost by waiting to collect nor does it include any cost of living adjustments. There is no incremental benefit to waiting beyond 70, so the month you turn age 70 is the limit.
If one has financial challenges or health issues that may lead one to assume a shorter than average lifespan, then priorities will change. Unlike a commercially available annuity, Social Security offers considerably more payout flexibility.
For married people, the 2015 Social Security overhaul greatly reduced a couple’s ability to game the system for their benefit. Only a small number of people still qualify for grandfathered options that were changed as of 2015. Going forward, married couples still have ways to maximize their Social Security incomes, though they are less than they were just a few years ago.
Strategies for married couples are dependent upon several factors. Key among them are the following:
- Age of the two people in the couple
- Relative incomes of the couple
- Health and expected lifespan of each of the people in the couple
- Savings that provide the flexibility to defer collecting Social Security
Assuming no lifespan issues, the base strategy has the primary breadwinner delay filing until age 70. By waiting, the surviving spouse will receive the maximum benefit upon the death of the primary breadwinner. The lesser earning spouse begins collecting at FPA. In this scenario, the lesser earning spouse will receive the higher of the lesser earning spouse’s earned benefit or the survivor benefit when the primary breadwinner dies.
If both people have similar incomes, the optimized strategy has both people waiting until age 70 to begin collecting. This maximizes long-run income and survivor benefits upon the death of either.
For a couple with one breadwinner, assuming good health and sufficient savings, the optimum strategy calls for the breadwinner to wait until 70. This strategy means the couple forfeits spousal benefits until the earner files. However, it offers the greatest lifetime retirement income and maximum survivor benefits. If the breadwinner files at FPA, the spousal benefit is maxed out when the spouse reaches FPA. Spousal benefit does not increase beyond FPA, meaning the couple would lose out on possible higher survivors benefits in future years.
The husband is a few years older than the wife and has been the primary breadwinner. The only time this combination resulted in a recommendation that the husband starts his earned benefit before age 70 was when both partners expected to live much shorter-than-average life expectancies — to age 78 for women and age 76 for men. Even then, the program recommended that the husband starts at age 68.
Delaying is often a beneficial strategy for two reasons:
- Social Security increases your benefit for each month between age 62 and 70 that you delay the start of your earned benefit. Social Security calls this increase “delayed retirement credits.” These credits are more generous than factors that would be based on pure actuarial principles. The reason is that Congress hasn’t changed the delayed retirement credits for many years, and it doesn’t yet recognize recent improvements in life expectancies and today’s low-interest rates.
- When the primary breadwinner dies, the surviving spouse usually receives a monthly income equaling the income the breadwinner was receiving during his or her lifetime, reflecting the delayed retirement credits. If you want to maximize the income your spouse will receive after you pass away, delaying the start of your benefits is a good strategy.
The strategies are complicated. They change based on relative ages, incomes, life expectancy, and an ability to defer collecting. People approaching retirement age are advised to consult a financial planner or other social security experts.
A widow or widower is eligible to collect the former spouse’s Social Security payments as a survivor benefit. If the person waits until FPA (note that survivor FPA is different from regular FPA – check the SSA documentation) to begin collecting, then the person collects 100% of the deceased spouse’s benefit. If his/her benefit based on the person’s earnings history is larger than the survivor benefit, the SSA will pay the higher benefit.
Alternatively, if the numbers work out, the widow(er) can file for survivor benefits before age 70 and then switch to collect on his/her earnings history at age 70. It is also possible to reverse the order of collection if the relative ages and benefits show it to be a worthwhile exercise.
Divorced people who were married for more than ten years, divorced for at least two years, and not remarried, can collect based on their ex’s work record. When divorced people collect, it does not affect the ex’s benefits in any way. People in this category are advised to seek professional assistance. Some people have even divorced two years before collecting to increase their benefits.
Social Security Calculators
The internet offers numerous social security calculators. These calculators can provide an analysis of payouts based on various inputs and assumptions. The Social Security Administration (https://www.ssa.gov/policy/docs/rsnotes/rsn2016-03.html) lists several calculators that it rates among the best calculators. The article identifies the pros and cons of each calculator and the information needed to use the calculators.
SSA, Retirement Estimator
The SSA has your official earnings history. The SSA has 11 calculators designed to assist in determining benefits, taxes, and other considerations based on your earnings history and that of your spouse, if applicable.
CFPB, Planning for Retirement
The Planning for Retirement calculator employs a three-step approach to analyzing various Social Security strategies.
CRR at Boston College, Target Your Retirement
The Boston College calculator looks at Social Security as part of a retirement portfolio.
AARP, Social Security Benefits Calculator
This popular calculator looks at maximizing Social Security benefits in a four-step process.
Financial Engines, Social Security Retirement Calculator
This is another four-step calculator that provides annual and lifetime income estimates.
Bankrate, Social Security Calculator
This calculator is relatively simple to use but does not provide information for a working spouse.
Readers should note that these calculators are planning tools. They make various assumptions leading to different numbers when the same situation is presented to each calculator. SSA has calculators that can tell you what will happen based on current information but cannot accurately forecast inflation and other variables that may affect future payouts. Readers are advised to research the numerous calculators available on the internet, mindful that they all make forecasts based on assumptions. Many are free or low cost. Calculator reviews can be helpful in identifying calculator tendencies, limitations, ease of use, and other factors that may affect the results they produce.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.