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The Social Security Act, created in 1935, has been amended over the years but is still a major income component during retirement. Understanding and choosing a Social Security benefit can be one of the most important retirement planning decisions you make. However, many retirees do not understand the complexities of the options available to them.
The earliest you can start receiving Social Security retirement benefits is age 62. Some people may not have an option to delay taking benefits. However, for those who don’t need the income now they may be better off by waiting. The age 62 benefit may be 30 percent lower than their full retirement benefit. Also if you plan to continue to work, your early benefit can be reduced even further. If you change your mind about taking an early benefit and are within the first 12 months, you can repay what you have received and restart your benefit at a later date. After 12 months, you can wait until full retirement age and then suspend your benefits. The income stops, but your benefits will begin to grow and a higher benefit can be taken in the future.
Full Retirement Age Benefit
The full retirement age benefit was originally established to be age 65. However, in 1983, an amendment was passed to increase the full retirement age from 65 to 67, beginning in the year 2000. Today, full retirement age is based on the year in which a participant is born. A full retirement age benefit will be significantly greater than an early benefit on a monthly basis—but it isn’t the maximum benefit you can receive. Your full retirement benefit will grow by roughly 8 percent for every year you wait until age 70. Those who have the option to wait past full retirement age will receive a healthy annual growth rate on their benefit.
A breakeven analysis is an important tool when trying to determine when a benefit should be taken. This analysis illustrates how many years it takes before waiting for a benefit pays off. By taking an early benefit, at age 62, you receive a benefit for more years but at a reduced rate compared to the full retirement age benefit. So at what point does waiting pay off? A high-level breakeven analysis suggest that an individual taking their full retirement age benefit would have to live at least 12 more years to breakeven versus the age 62 benefit. Someone considering the age 70 benefit would have to live roughly 13 more years to breakeven versus the full retirement age benefit. Please note that the above is high level—there are many variables and factors that will change the breakeven point.
If you are married or were married, the decision on what benefit to take becomes even more complex. Having a spouse provides you the option to take a benefit based off your earnings, and/or a benefit based off your spouse’s earnings.
One advantage of having a spousal option is that a wife at full retirement age can take her benefit. Her husband can then apply for a spousal benefit and receive half of her benefit as long as he is also at full retirement age. He can then delay his benefit and begin taking it at age 70. I recently helped a client realize he could be receiving an extra $600 a month just by applying for a spousal benefit. The nice thing is his benefit isn’t affected by the spousal benefit and continues to grow.
Another strategy is to apply for and suspend a benefit. This strategy works if spouses are close in age and one spouse has a significantly higher full retirement age benefit. For instance, Jane’s full retirement age benefit is $2,500 and her husband John’s is $700. Jane could apply for her benefit at full retirement age and then suspend her benefit. Her benefit would continue to grow until she decided to take it in the future. In the meantime, John could start taking his spousal benefit based on Jane’s full retirement benefit amount. If John started drawing his own benefit, he would only receive $700 per month, but because Jane applied for and suspended her benefit, John could start receiving $1,250 per month, or half of Jane’s benefit.
You may have heard that the Social Security Trust Fund is scheduled to run out of money by 2033. While we can’t know what the future holds we know there are risks.
There is the potential that the full retirement age could be raised further. Or perhaps more of your retirement benefit could be subject to taxes. A means test could be implemented, which would serve to reduce benefit amount for individuals with income and/or assets above a certain threshold.
While it is anybody’s guess what changes the future holds, it is certain that a significant risk to your Social Security benefit is making a decision without understanding and evaluating your options.
Devin B. Pope, CFP, MBA, is a personal financial adviser with the Albion Financial Group.