Financial Planning for Social Security Retirement Benefits
Social Security Retirement Benefits can be surprisingly complex. There are tons of different factors and situations that can impact your decision on when to collect social security. Each person’s situation is unique depending on your health, marital status, employment, and financial situation.
The best starting point for your personal analysis is creating a My Social Security Account with the Social Security Administration. They will give you a statement with an estimate of your benefits at 3 different ages: 62, full retirement age, and age 70. Full retirement age differs depending on when you were born as discussed later.
There are no hard and fast rules for optimizing social security because everyone’s situation is so unique. That being said, on average the optimal financial outcome (based on actuarial life expectancy) is to delay benefits for as long as possible. But that doesn’t mean it’s the optimal strategy for your situation.
Here are the basics of social security:
Your annual retirement benefit is based on your highest 35 years of earnings. You have to pay into the system for at least 10 years to be eligible for benefits. You can begin collecting as early as age 62. However, if you take your benefits before your full retirement age you will receive a reduced amount. On the other hand, if you wait past your full retirement age your benefits will actually increase. Full Social Security retirement benefits kick in between age 66 and 67 depending on the year you were born. Here’s a table breaking down the full retirement age:
Benefits go down by 6.67% for the first 3 years before full retirement age and then go down by 5% each additional year until age 62. If you delay your benefits you can gain an additional benefit of 8% per year until age 70.
Here’s what the benefit looks like for anyone born in 1960 or later:
If you were never married you would look at your current financial (and life) situation and determine how to maximize your lifetime benefit. Obviously, you’re dealing with an uncertain future but the goal is to select the option most likely to give you the best outcome. Here are some questions to consider:
- Do you have a job or other assets you can live off of to consider a delayed social security strategy?
- How’s your health?
- How are your longevity genetics?
Here’s a table showing breakeven ages to maximize your lifetime benefit. What the table shows is the age you need to live to for your delayed benefit to be greater (the top row) versus taking it earlier (the left column). For instance, if you look at age 62 on the left and compare it to age 63 on top, it tells you that you’d need to live to age 77 to be better off taking the benefit at age 63 as opposed to age 62. If you took the benefit at age 70 on top instead of age 62 on the left, you’d have to live to age 80 for delaying to be more beneficial.
Here’s a table showing actuarial life expectancies with data from the Social Security Administration:
Comparing the breakeven ages in the previous table to actuarial life expectancies you can see that on average a Social Security retirement benefit would be maximized if it was delayed and allowed to grow.
However, the breakeven analysis ignores investment returns. Many retirees who claim social security benefits early will be able to let their investment portfolios continue to grow, so the value in delaying social security is lower.
Capital Gains Tax Avoidance
There are other potential planning considerations as well. For instance, if you’re sitting on capital gains and have assets you can live off of you might consider delaying social security so you can put yourself into a zero capital gains tax bracket and sell off some of those assets (For married filing jointly couples with less than $80,800 in adjusted gross income there is no capital gains tax in 2022. For single individuals the income limit is $40,400).
Taxes on Social Security Benefits:
The amount of your Social Security retirement benefit that’s included in your taxable income is based on your combined income. Combined income is equal to your adjusted gross income plus nontaxable interest plus ½ of your social security benefits. Here’s the amount of your benefits taxable by income amount:
|Married Filing Jointly
Spousal Benefits Strategy
Spouses can take a benefit equal to 50% of the earner’s benefit once the earner has filed. Just like with the earner’s benefit, a spousal benefit is reduced if you take the benefit early (and again you can’t take it before 62). Here’s the payout for a spouse born in 1962:
As the table above shows, there is no benefit to waiting past full retirement age for the spousal benefit. Congress passed a law in 2015 that no longer allows a spouse to claim spousal benefits and later switch to their own benefits, eliminating a popular strategy for maximizing social security.
One popular strategy is for the lower-earning spouse to take their benefits early at age 62 but the higher-earning spouse to delay their benefits until full retirement age or beyond. Then if the higher-earning spouse passes away, the lower-earning spouse will receive the full benefit the higher-earning spouse was earning.
Widows have the most planning flexibility under the current Social Security rules. Widows can claim survivor benefits as early as age 60. Claiming early reduces the benefit amount just like with other benefits. However, widows have a unique feature that others don’t have. Claiming survivor benefits doesn’t impact their own benefit based on their work history, so you could claim your survivor benefit early and allow your own benefit to grow and collect it either at full retirement age or later after it has grown. Alternatively, you could claim your own benefit at age 62 and then switch to the full spousal benefit at age 65.
Divorced Spouse Benefits
If you and your ex-spouse are 62 or older and were married for 10+ years then you qualify for divorced-spouse benefits. As long as you’ve been divorced for at least 2 years you can take this benefit even if the other spouse hasn’t taken benefits yet. The benefit amount is the same as the spousal benefit for a married couple so it’s 50% if at full retirement age and goes down if you take it early. When the other spouse passes away the benefit goes up to 100% of their benefit.
If you’re approaching retirement and would like to discuss your situation, schedule a complimentary call today.
Scott Caufield, CFA, CPA