How To Plan For Your Social Security Benefits

Once considered the un­touchable “third rail” in politics, talk of reforming Social Security is now on the table. Not that much is being accomplished at this time aside from casting blame and using scare tac­tics, but it does seem that at long last we may see some real reform to keep the system liquid.

Benefit Cuts Are Imminent

Surprisingly, even AARP announced support for cuts in benefits, as long as they take place gradu­ally over a long period of time and don’t affect seniors already receiving benefits. So with changes likely to come, should you grab your benefits while you can?

The answer to that question is complex, and unique to each person or couple’s life situation.

While Social Security was never designed to be the sole source of retirement income, it is a significant income stream, designed to rise with inflation to boot. It should be managed with care.

Your eligibility

To be eligible for Social Security, you must be employed in a job that participates in the Social Security system for about 10 years. Your benefit amount is calculated based on your highest 35 years of earnings, indexed for wage increases along the way.

If you haven’t worked for a full 35 years, the years you were out of the workforce will count as zero and bring the average down. On the other end, earnings are only counted up to a capped amount that is determined annually, no matter how high they may be. In 2011 that cap is $106,800 (good news there is that the Social Security wage tax also caps at that income … for now). Those 35 years of earnings are then converted to a month­ly amount to come up with your “average indexed monthly earnings,” or AIME. That number then goes through a calcula­tion to come up with your benefit amount, or “pri­mary insurance amount,” PIA. One way to increase your benefit is to stay in the workforce long enough to replace lower or zero earning years with your current higher earnings.

When to Take Social Security

When it comes time to collect Social Security, age matters. You may choose to claim benefits generally any time after you turn 62, with the actual ben­efit amount varying with your age at that time. The full retirement age (FRA) is between 65 and 67, de­pending on your year of birth. For instance, FRA is age 66 for those born between 1943 and 1954, and 67 for all those born in 1960 and later If you claim Social Se­curity at your FRA, you will receive 100 percent of your benefit amount.

Claiming early results in an actuarially reduced amount, a 62-year-old today would only receive 75 percent of his or her PIA. If that person waits until age 70 instead, the benefit amount is 132 percent. That significant difference is meant to make up for the fact that the recipi­ent will receive fewer checks over the course of his or her lifetime.

Married? You may choose to claim 50 percent of your spouse’s benefit instead of your own. If you are di­vorced, and were married for at least 10 years, you can still claim based on your former spouse’s earnings, as long as you are at least 62 or older and unmarried, regardless of whether your former spouse has started re­ceiving benefits or not.

It doesn’t matter if you haven’t seen your “ex” for many years. You can apply without his or her knowledge or consent; no messy conversations necessary. You do have to be divorced at least two years, though, and your former spouse must be eligible for benefits and at least age 62. If you wait until your full retirement age, you will receive 50 percent of his or her benefit, and if you claim early, you will receive a reduced benefit. It doesn’t matter how many ex spouses your former spouse has; they all can claim on his record, without affecting the benefit of any others.

Social Security provides for a sur­vivor benefit for both spouses and ex­spouses. If your spouse (or ex) dies, you may apply for survivor benefits from age 60 on. But again, if you ap­ply prior to full retirement age, your benefits are reduced. At full retire­ment age the amount is 100 percent of the deceased spouse’s. One strategy to explore is to claim a reduced survivor benefit at age 60, and then switch to your own benefit at your full retire­ment age.

This switching strategy can work for married couples as well. One spouse can file at full retirement age, and then suspend the claim. This allows the other spouse to claim 50 percent of his benefit, while he waits until age 70 to start receiving ben­efits, when the amount is higher. Or a higher earning spouse may claim on the other spouse’s benefit and switch to his own later. You will need to visit your local Social Security office to file this way and make sure it is done correctly.

Is it better to claim as early as pos­sible, in case Social Security runs out of money? In my opinion, we will be able to fix Social Security through means like a higher payroll tax rate, higher wage caps, or reduced benefits for those who aren’t collecting yet. I don’t believe that retirees or soon-to­-be retirees will see a benefit reduc­tion.

Considering Medicare

Medicare is another story, and one for another column. Setting aside solvency fears, it’s best to take a ra­tional, not emotional approach to the timing decision. The main factors to consider are your health and life expectancy, whether or not you are still working, your financial situation and your lifestyle. The first two are fairly straightforward: If you are sick or have serious health issues, then collecting sooner rather than later is probably the way to go.

On the other hand, if you claim prior to your full retirement age and continue to work earning more than $14,160 a year, you will forfeit $1 in benefits for every $2 you earn in excess of that. When you do stop working, at full retirement age Social Security will recalculate and increase your benefit amount to account for the months that you had benefits withheld. Your early benefit will still not equal the benefit you would have received if you claimed at full re­tirement age. You may also have an increase in benefits due to additional years of higher earnings. There is no reduction in benefit once you reach full retirement age, although there are special rules for the year you reach that age.

Beyond that, you’ll need to do a break even analysis, and weigh the merits of collecting an increased ben­efit through delaying and pulling ad­ditional income from your portfolio vs. taking payments early or on time and allowing your portfolio to grow.

A key factor is that cost of living in­creases have more of a compounding impact the higher your starting ben­efit amount. Your personal tax situa­tion enters into this decision as well.

There are a number of calculators and tools available on the Social Secu­rity website to give you a start.

Here are just two:

  • SSA Benefit Calculators
  • Retirement Estimator

You may also wish to speak with a Social Security representative for more individualized information.

Originally published in the Pocono Record, July 24, 2011

About the author

Erin Baehr CFP®, EA

Financial Advice for Everyday Life

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