With employment opportunities becoming increasingly challenging for seniors, more and more clients in their 60s are addressing social security issues sooner than they expected, and many of them have these questions:

  1. Early Retirement Benefits: When should I begin taking my benefits?
  2. Taxation of Benefits: How can I minimize the tax on my benefits?
  3. Delayed Retirement Credits: Does it make sense to postpone my benefits?
  4. Spousal Benefits: When should my spouse take benefits?
  5. Benefit Contingency Plans: How can I replace some/all of my benefits if social security changes?
  6. Strategies to Consider: What tactics might enhance my lifetime benefits?

Early Retirement Benefits

Allows eligible recipients to begin receiving their benefits four to five years prior to their full retirement age (65-67 depending on year of birth).  The major disadvantage is that benefits are reduced by 20-30 percent for the recipient’s lifetime; spousal benefits can also be limited depending on circumstances.

Despite these drawbacks, about 45 percent of eligible Americans elect to receive early benefits (SSA Annual Statistical Supplement, released Nov. 2019). Early benefits have appeal to those who are not working, need cash flow, and/or are concerned that social security’s days may be numbered—a “take the money and run” philosophy.

Helping clients calculate their “break-even age” can assist with this decision.  As an example, if you are currently 62 and your full retirement age is 66, your monthly benefit of $1,600 would be reduced to $1,200 (by 25 percent) if you started today.  By about age 77, you could break even (total early benefits would equal those received at full retirement) at $230,400.  The break-even age increases to age 82 if we assume the early benefits were invested at 6 percent annually.  So, in this simplified example, if the client has a high probably of living past 77 (or 82, depending on your assumptions), he/she would be better off waiting until full retirement.  The Social Security Administration’s on-line calculator (https://www.ssa.gov/planners/calculators/) is a great resource to help with these calculations. 

Early Benefits Earning Limits

For those who take early benefits and are employed with compensation over the “earnings limit,” Social Security will take back $1 of benefit for every $2 earned over the limit. This continues until the year in which full retirement age is reached. During the year they reach full retirement age, the new earnings limit applies only for the period before the month they reach FRA. If earnings exceed the limit in this period, benefits are reduced $1 for every $3 earned over the annual earnings limit.

The amount that is withheld, however, may not be lost. That is because the SSA will, after full retirement age, recalculate the benefit amount and give credit for any months when benefits were reduced because of earnings.

Taxation on Benefits

Benefits can be taxed as ordinary income, depending on the recipient’s Preliminary Adjusted Gross Income. Preliminary Adjusted Gross Income (P-AGI) includes earnings, pensions, interest, dividends, municipal bond interest, and 50 percent of social security benefits.  For P-AGI over certain amounts, a percentage of benefits become taxable. This applies to all social security recipients; there is no age forgiveness so it is important to check the prevailing AGI threshold to coordinate discretionary income such as IRA withdrawals.  We might consider “bunching” income and deductions in alternate years.

Delayed Retirement Credits

For those who postpone benefits and continue working past full retirement age, their lifetime benefit can be increased up to 8 percent for each additional year worked through age 69. The precise formula is based on birth year.  So for a client who is 66 this year and entitled to $1,600 of full retirement benefit today, working an additional two years could increase their monthly benefit to $1,856.  Thus, for clients who are active, in good health and have a family history of longevity, there may be benefit to continue working. (see http://www.ssa.gov/OP_Home/handbook/handbook.07/handbook-0720.html)

Spousal Benefits

For those age 62 and over whose spouses are alive and receiving benefits, they may be eligible for spousal benefit even if they do not have enough of their own work credits or have never worked at all. The maximum is 50 percent of the spouse’s benefit and may be reduced depending on how many months prior to full retirement age that payments begin.  Upon application, the Social Security Administration will automatically pick the greater of the spousal benefit or actual benefit based on own work credits.

The wife’s benefit may be optimized if she claims her benefit at age 62 [1]. Because most husbands have higher lifetime earnings and shorter life spans, women often receive the majority of spousal and survivor benefits.  When a spouse dies, the survivor can claim the greater of their own earned benefit or their spouse’s earned benefit.  This may be reduced if claimed prior to full retirement age.  

Benefit Contingency Plans

We prepare clients for a number of possible changes as the social security system works to remain viable. Proposals that may be considered include:

  1. Raising the ceiling on the maximum wage base from current levels ($137,700 in 2020) to $250,000;
  2. Accelerating by 5 years the gradual increase in full retirement age to 67;
  3. Modifying the benefit calculation to reduce benefit growth;
  4. Introducing “means testing” that could increase taxation and/or reduce benefits for recipients with household income over specified thresholds.

Whatever the outcome, it is critical that we offer clients “contingency plans” capable of replacing benefits that could be lost as a result.

Strategies to Consider

Taking Early Benefits and Investing the Cash: Consider the above example wherein a client begins his $1,200 early benefit at age 62 and invests it at 6 percent annually. After 5 years he would have about $57,811 accumulated, which could potentially generate the $400 per month difference (between full and early retirement benefit) for about 22 years.  But if the money earns 3 percent, that benefit is only generated for about 13 years.  Obviously much here depends on actual investment returns and longevity.

Make Up for Low Earnings Years: In general, for those born after 1928, benefits are calculated by averaging 35 highest years of indexed earnings. For those who made little or nothing in one or more of those 35 years (often those who took off to raise family), waiting to retire until normal retirement age might increase benefits because each year they wait to retire gives a chance to earn enough to replace a lower year of earnings in the calculation.

Social Security Buy Back: Undoing a decision to receive early retirement benefits could be advantageous under certain circumstances.   Say a couple, both now 70, took early benefits at 62 and now receive $11,556 annually.  Had they waited until 70, they would be receiving $20,000 annually instead, despite their not having worked since age 62.  If they each pay back $79,305 in benefit and reapply, they effectively purchased an additional $8,444 of annual inflation adjusted annuity benefits.

Bottom line, there are no hard fast rules as each client situation needs to be evaluated based on their individual circumstances. Also, while we can educate, there is no substitute for the client having a face-to-face meeting with a Social Security Administration representative and consulting their tax adviser. As advisors we can add tremendous value by making clients aware of the various issues and guiding them through their decision making process.

[1] The Social Security Claiming Guide with Alicia H. Munnell and Andrew D. Eschtruth. 2016. Chestnut Hill, MA: Center for Retirement Research at Boston College.

Uncertainty over the economy and financial markets has many people concerned about their financial futures. For friends, relatives and colleagues who may find this information helpful, please feel free to share with them.  Remember, for those who could benefit we offer a complimentary “Second Opinion” that can offer an objective financial review. Keep us in mind for those who may be seeking a wealth management practice like ours—one that delivers services according to the needs and perspectives of its clients.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Wells Fargo Advisors Financial Network LLC (WFAFN) does not provide tax or legal advice. We strongly recommend an advanced tax and estate planning expert be contacted for further information. Any opinions are those of Mitchell Kauffman and not necessarily those of WFAFN. The information has been obtained from sources considered to be reliable, but Wells Fargo Advisors Financial Network does not guarantee that the foregoing material is accurate or complete.  Prior to making a financial decision, please consult with your financial advisor about your individual situation.

Mitchell Kauffman provides wealth management services to corporate executives, business owners, professionals, independent women, and the affluent. He is one of only five financial advisors from across the U.S. named to Research magazine’s prestigious Advisor Hall of Fame in 2010.

Inductees into the Advisor Hall of Fame have passed a rigorous screening, served a minimum of 15 years in the industry, acquired substantial assets under management, demonstrate superior client service, and have earned recognition from their peers and the broader community.

Kauffman’s articles have appeared in national publications, and he is often quoted in the media. He is an Instructor of Financial Planning and Investment Management at the University of California at Santa Barbara.

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