In this post I’ll summarize the key variables that go into Social Security and identify ways to maximize benefits for both individuals and couples.
It is important to point out that the best decision can vary based on life expectancy and existing medical and financial conditions. For these, it is a good idea to get help in reviewing options with your tax and/or financial planner. For example, much of the discussion focuses on delaying benefits to maximize monthly payments. In a scenario where life expectancy is below average, this may not be the right approach.
Maximize Eligible Earnings During Working Years
The benefits you receive are based on your lifetime earnings history. Full retirement benefit is based on the highest 35 years of your work history, with indexing for average US wages up through age 60. To ensure your benefits are maximized, consider how potential career choices or early retirement decisions impact your eligible earnings.
Delay Filing for Benefits Until Full Retirement Age or Better Yet, Until Age 70
Full Retirement Age (FRA) is based on the year you were born. For most readers, the Full Retirement Age is between 66 and 67 years. Taking early benefits reduces monthly payments. Depending on your age, the reductions will likely be in the 25 – 30% range.
It is possible to delay filing for benefits until age 70. Benefits increase over the FRA benefit by 24 – 32%, depending on birth year. In order to delay filing, good financial planning is needed. Your plan should ensure that you have enough savings in personal and retirement accounts to enable pushing out the benefit date. As noted above, the monthly payments can be significantly larger. Consider a person born in 1960 who take benefit at age 62 and receives just 70% to one that delays until age 70 and receives 124%, a 77% greater benefit by waiting as long as possible!
Longevity risk is the risk that we outlive our assets in retirement. Social Security pays until we die, and as such is one of the best options most people have to mitigate longevity risk. Delaying benefits increases income and cuts down on longevity risk.
For Couples, Delay Filing of Spouse with Largest Benefits
Social Security provides a benefit of 50% to spouses. In order to receive a spousal benefit, the primary earner has to have filed for benefits. Therefore, it is best to delay filing for benefits as long as possible for the spouse with the largest benefit. For a spouse that is entitled to both a direct benefit and spousal benefit, any claims are first drawn from direct earnings benefits and then capped at the amount of the 50% spousal benefit (if larger than the direct earnings benefit). If you are divorced and were married for 10 years you may still receive spousal benefits as long as you are unmarried, over age 62, your former spouse is entitled to benefits and your own benefits are less than the spousal benefit you may qualify for.
Maximize Survivor Benefits by Delaying Initial Claim
When one spouse dies, the surviving spouse is entitled to assume the benefit of the first. As such, again the best scenario is to delay the point at which benefits begin.
Minimize Taxes
Social Security benefits are taxed at the Federal level and at the State level in thirteen states. California, Oregon and Washington do not tax Social Security benefits. At the Federal level, the percentage of benefits that are taxed is based on your ‘provisional income’ level. Provisional income is the sum of your adjusted gross income, tax exempt bond interest plus 50% of Social Security benefits. Singles/couples with less than $25,000/$32,000 pay no taxes on benefits. Fifty percent of benefits are taxed if provisional income exceeds this level until income reaches $34,000/$44,000 for singles/couples. At this point, 85% of benefits are taxed.
There are a number of strategies that can be used to reduce the tax burden. I will outline a few examples. The strategies get complicated quickly and will vary based in your personal circumstances, so it is best to discuss this with your tax advisor or financial advisor. Distributions from traditional IRA and 401(k) accounts are treated as income. One strategy would be to take distributions from these accounts and delay the distributions from Social Security as long as possible. Also, it may be possible to take distributions from these accounts that exceed the RMD amounts to help reduce the future tax rates on the Social Security benefits. Roth IRA distributions are not included in the ‘provisional income’ calculation so, a Roth IRA is preferred over traditional IRA or 401(k) and could help save on future Social Security benefits. Charitable contributions made directly from IRA account can be used to meet RMDs while reducing ‘provisional income’. Legislation passed in 2014 allows one to reduce the RMDs from IRA, 401(k), 403(b) and 457 retirement accounts by up to $125,000 to purchase a qualified longevity annuity contract. This type of contract may or may not be suitable for your situation, so check with your advisors.
Advanced Strategies
The Bipartisan Budget Act of 2015 changed a number of rules associated with certain claiming strategies (some call ‘loopholes’ because they were unintended). Strategies such as ‘claim and suspend’ and ‘spouse then worker’ allowed couples to maximize benefits in a way that individuals could not. These strategies have been closed prospectively. Certain people who filed before 2016 may have been grand-fathered in. Certain of the rules are still in place for widowed or divorced spouses.
Conclusions
Understanding how Social Security benefits are determined and taxed should help investors to maximize their after-tax retirement income. Although the Bipartisan Budget Act of 2015 modified or eliminated some of the more complex benefit claims strategies, Social Security benefits, tax implications and interaction with other retirement and savings accounts is complicated. If you have substantial investment, retirement accounts and/or Social Security future benefits it may be worth your time to discuss your retirement income and tax planning with your CPA, tax advisor and/or financial advisor.