Social Security Timing Has Its Benefits
Presented by Gerard Longo, AIFA®, CPFA®:
For many Americans, social security benefits make up a significant portion of retirement income. When it comes to how much you will receive, you may be surprised to learn that you have a choice in the matter—and timing is everything. The longer you wait to claim your benefits, the larger your monthly payment will be, so when you start can determine whether you’ll have sufficient funds to achieve your retirement goals. Here are considerations to keep in mind as you think about your social security timing and choices.
When Are You Eligible to Claim Social Security?
Based on the year you were born, the Social Security Administration (SSA) has determined your full retirement age (FRA)—in other words, the normal retirement age at which you become eligible to receive full social security benefits.
If you were born in:
Your FRA is:
|1937 or earlier||65|
|1938||65 and 2 months|
|1939||65 and 4 months|
|1940||65 and 6 months|
|1941||65 and 8 months|
|1942||65 and 10 months|
|1955||66 and 2 months|
|1956||66 and 4 months|
|1957||66 and 6 months|
|1958||66 and 8 months|
|1959||66 and 10 months|
|1960 or later||67|
Figure 1. Full Retirement Age (FRA)
Your social security retirement benefit is based on an average of your highest 35 years of earned income, adjusted for inflation. This may include years with zero earnings, such as when a parent takes time off to raise children.
Working additional years will never reduce your benefits because low-wage years never replace higher-wage years. In fact, working part-time in retirement will usually help increase your primary insurance amount (PIA)—the basis for determining benefits—even if you are already drawing benefits. You may not realize the increase immediately if your benefits are temporarily reduced because you earn too much.
Although earned income over the threshold can result in a reduction of benefits for retirees who are under their FRA, it is only a temporary reduction. The Social Security Administration (SSA) will recalculate the worker’s benefit at FRA to account for any months in which the social security benefit was completely offset (i.e., any months in nonpay status). Also, because the earnings will be credited to the worker’s history, they may result in an increased benefit at FRA.
Excess Earnings Test. If you receive a combination of your own benefits and a spousal benefit, only the spousal portion is affected by your spouse’s excess earnings. Even if you apply for social security midyear. Only your earnings from work after you apply for social security are factored into the excess earnings test. Your earnings prior to retirement do not cause an offset of your benefits.
The Early Bird Gets Less
Although your FRA serves as the baseline, you can claim your social security benefits at an earlier age. Keep your social security timing in mind, though. Taking your benefits early will permanently reduce the amount you receive, up to 30%.
Let’s say your FRA is 66 and your monthly benefit amount is $1,000. If you decide to take benefits at age 63, your monthly benefit will be permanently reduced by 25 percent. That might be a hefty sum to leave on the table, so remember that you have up to 12 months to withdraw your application for benefits if you change your mind. In this instance, you can apply for reduced benefits prior to FRA and then, within 12 months, withdraw the application and reapply later. You must, however, pay back all the benefits you received, including dependent benefits.
Good Things Come to Those Who Wait
If you don’t need the cash when you reach your FRA, you can opt to delay your claim—and the SSA offers an economic incentive to do that. Should you decide to wait until after you’ve passed your FRA, the SSA compensates you for allowing those funds to stay in its reserves by guaranteeing an 8 percent increase in benefits for each year you delay, up until age 70. So, if you wait until 70 to claim benefits, your payment will be 76 percent more than what you would have received if you claimed early at 62. If you’re in a position to do so, it literally pays to wait.
Remember, though, that the maximum benefit amount you can receive tops off at age 70, so there’s no financial motivation to delay your claim past then.
Married couples should consider various strategies for maxing out benefits. If you’re the primary earner, you’ve been married at least one year, and your spouse is at least 62, your spouse may qualify for a spousal benefit of up to 50 percent of your FRA benefit when you make your claim. Although your dependent spouse receiving a benefit won’t affect the amount of your benefit, keep in mind that if you make an early claim, your spouse’s benefit will also be reduced. The flip side is, if you wait until age 70, you maximize benefits for both of you—and potentially the survivor benefit for your spouse.
If you have two incomes, for example, depending on your benefits estimates, you might consider making your claims at different times. It may make sense for the lower earner to take benefits first when they reach their FRA, and the higher earner to wait until age 70 because their increases will amount to more over time. Depending on life expectancy, this approach could also mean a higher survivor benefit for the lower earner should the higher earner pass away first. Note, however, that your spouse’s benefits will be permanently reduced if they apply before their FRA. (There is an exception if they are caring for a dependent child younger than 16 who has a disability, making them eligible for dependent benefits.) For dual earners born before 1954, you can opt to apply for only the spouse benefit and delay taking your own benefit until a later date.
If you and your spouse have similar lifetime earnings, each of you might want to wait until age 70 if it’s financially viable. This positions both of you to receive the maximum amount and ensures that one of you receives the highest possible survivor benefit after the other passes away.
While you are living, your spouse can receive a dependent benefit of up to 50 percent of your full retirement amount. Benefits paid to your spouse will not decrease your retirement benefit. In fact, it is possible to receive a combination of benefits as a worker and as a spouse, although the maximum you will receive is the higher of the two.
You cannot get spousal benefits until your spouse has applied for Social Security retirement benefits. You can apply for a benefit based on your work record and, when your spouse retires, qualify for a spousal benefit, if higher, at that time.
Widows and Widowers
If you are widowed, you have some decisions to make when it comes to claiming social security benefits. You may be eligible to claim benefits based upon either your own earnings record or that of your deceased spouse.
To qualify for survivor benefits, your deceased spouse must have been “fully insured” under social security regulations at the time of passing. For most, this requires a minimum of 10 years of full-time work covered under social security. For younger individuals, this amount may be reduced.
Even if your deceased spouse didn’t have the number of credits needed, social security may pay benefits to you and your children if you are caring for the children. In this situation, you and your children may get benefits if your deceased spouse had just six credits or one and one-half year’s work in the three years preceding his or her death.
In addition, you must meet the following qualifications:
- You must have been married at least nine months prior to your spouse’s death.
- You must be at least 60 years old. If you are younger than 60, you must be caring for a child younger than 16 or you must be disabled and receiving benefits.
- If you are divorced, you must remain unmarried until age 60.
Survivor benefits represent 100 percent of the deceased’s social security primary insurance amount, plus any delayed retirement credits. If, however, you claim before your full retirement age (FRA)—as determined by social security rules—the benefit amount will be reduced by a maximum of 28.5 percent. This means you will never receive less than 71.5 percent of the full retirement benefit.
Spousal Benefit After Divorce
To collect a spousal benefit based on your living former spouse’s earnings record, you generally must meet the following criteria:
- You are not remarried.
- You are at least 62 years of age.
- Your marriage lasted at least 10 years.
- Your own social security benefit based on your earnings record is less than the spousal benefit of your living former spouse.
If you’ve been divorced for at least two years and your former spouse is at least age 62, you can file for this benefit regardless of whether your living former spouse has already filed for benefits or has remarried.
If your former spouse is deceased, the requirements are slightly different. If you remarried—but the marriage took place after you reached age 60 (age 50 if disabled)—you may be eligible for survivor benefits on the deceased former spouse’s earnings record.
- What happens when my spouse, or divorced spouse, dies? You can receive widow or widower benefits at age 60 (age 50, if you have a disability). You will get a survivor’s benefit equal to 100 percent of your spouse’s benefits. You will not, however, receive both your spouse’s and your own benefits. The amount you receive will depend on your age at application for widow(er) benefits and whether your deceased spouse was receiving reduced benefits. Please note: A widow or widower has the option of taking a survivor benefit now and then switching to an unreduced benefit based on his or her own work record any time after FRA, or vice versa.
- What happens if I remarry? If you are a widow(er) or divorced widow(er) and you remarry before age 60 (age 50, if you have a disability), you are not eligible for your deceased spouse’s benefits. You can, however, apply for spousal benefits under your new spouse. If you remarry after age 60 (age 50, if you have a disability), you can choose between your deceased spouse’s survivor benefits or your new spouse’s spousal benefits.
Deciding the Right Time to Claim Social Security
Claiming your benefits as soon as you reach your FRA shouldn’t be a given—nor should holding out longer for a bigger benefit. The right timing depends on your specific circumstances, and there’s a lot to consider. Depending on your specific financial situation, deciding when to claim your social security benefits may have a significant impact on your retirement goals. Time may be on your side if you’re looking to maximize your benefits, but the choice can be complicated; it depends on your health, family circumstances, and overall financial wellness.
From a purely mathematical point of view, most people are better off waiting to start collecting their social security benefits, but there are questions you need to ask yourself:
- Do you need the cash? If you need help paying for basic living expenses, you probably should elect to begin receiving benefits as soon as possible.
- How is your health? If your health and family history predict a long life, you may be better off delaying your benefits until FRA or later. If you don’t expect to attain a normal life expectancy and you are single, consider taking benefits early. But if you are married, be aware that doing so will reduce your spouse’s survivor benefit.
- Life expectancy. Longer life expectancies are a large factor in determining the best claiming strategy, so a break-even analysis—the age when your cumulative benefits will even out—can provide helpful insight. Handy life expectancy calculators and benefits calculators are available to help you estimate your benefits based on the age you want to make your claim.
- Will you continue to work? The SSA will recalculate your benefits at your FRA and credit any months when your earnings from work completely offset your monthly benefit. Further, since your benefit includes your highest 35 years of indexed earnings, wages you earned today may replace lower-earning years in the benefit calculation, which could result in higher benefits.
- How much do you earn from pensions and other investments? To determine your income for this purpose, the IRS looks at wages, self-employment, interest, dividends, and otherwise tax-free municipal-bond income. The IRS adds all these to one-half of your social security benefit to determine how much of your benefits will be taxed.
- Are you in a high tax bracket? Because social security benefits may be taxed, those in the highest tax brackets and with other sources of income can benefit from delaying social security, thus deferring taxes.
- Were you or your spouse born in 1953 or earlier? Normally, if both you and your spouse are living, the SSA will pay you the higher of your own social security retirement benefit or 50 percent of your spouse’s benefit. If you were born in 1953 or earlier and delay benefits until your FRA, however, you will have a choice of either benefit. One strategy would be for the lower-earning spouse to take reduced benefits after age 62 and for the higher-earning spouse to wait to take a spousal benefit at his or her own FRA. Then, at age 70, the latter would switch to a benefit based on their own work history. This would allow you to accrue delayed retirement credits and provide a higher benefit. But, because the rules are somewhat complicated, consult your local Social Security office about your eligibility for this strategy.
- Are you a surviving spouse? Reduced survivor benefits are available at age 60 and at FRA, you are eligible for 100 percent of what your spouse’s benefits would have been if they were living. Taking a reduced survivor benefit does not affect the benefit based on your own earning history. Thus, you can apply for a survivor benefit and switch to your unreduced retirement benefit at your FRA or later.
- Will you spend or save your social security benefits? You may be able to earn more on your reinvested payments than you lose by taking a reduced benefit. A tax professional can calculate the after-tax, break-even interest rate that would be necessary for this strategy to make sense.
- Are you affected by the Windfall Elimination Provision? Keep in mind, if you or your spouse worked at a job at which you didn’t pay into social security because you were earning a pension, your retirement and your spousal/survivor benefits may be affected by the Windfall Elimination Provision and Government Pension Offset. (This is common for teachers and government employees.)
Before you claim social security, always check with the SSA to find out which benefits you’re entitled to claim. Verify your earnings history with the SSA’s records and correct any errors. Based on the social security benefit statement and your recent tax records, a tax preparer or financial advisor can run financial models to help you make your decision. As a general rule of thumb:
Take Your Benefits Early
- If you need the cash flow to pay living expenses
- If you prefer the flexibility of investing benefits
- If you’re not in good health and are single
Wait until your FRA
- If you are still working and earning more than $18,960 (2021)
- If you want to receive the highest spousal benefit available
Delay benefits up to age 70
- If you want to increase your monthly benefit
- If you are very healthy and have a family history of long life expectancies
- If you want your spouse to receive the highest survivor benefits
Social Security Tax Implications
Generally, social security benefits are taxable only if you earned income, such as from wages or investments after retirement, in addition to your benefits. Understanding when tax is triggered can help reduce the tax burden.
How Social Security Tax Is Determined
No more than 85 percent of your social security benefit is added to taxable income—and probably less. Actual tax is determined by modified adjusted gross income (MAGI) and marginal tax rate, which can range from 10 percent to 37 percent of taxable income—or more, if your state taxes social security benefits.
- Calculating MAGI. To find out whether your benefits are taxable, calculate your MAGI. For you and your spouse, add the following:
- 50 percent of social security retirement benefits
- All income, including tax-exempt interest
- The amount you come up with is your MAGI
Even if your spouse doesn’t receive benefits, you must add your spouse’s income to yours in order to determine whether your social security benefits are taxable.
Undistributed gain for a tax-deferred annuity is not included in the calculation, nor are distributions from a Roth IRA that has existed for five or more years if you are older than 59½.
- Base amount. Once you have calculated your MAGI, compare it with the base amount, which is the maximum combined income you can earn or receive before social security benefits are taxable. Your base amount is:
- $25,000 if you are single, head of household, or qualifying widow(er)
- $25,000 if you are married filing separately and lived apart from your spouse for the entire tax year
- $32,000 if you are married filing jointly
- $0 if you are married filing separately and lived with your spouse at any time during the tax year
- If your MAGI is greater than the base amount, your social security benefit is taxable. For most retirees, up to 50 percent of benefits are taxable. Up to 85 percent of benefits can be taxable if one of the following situations applies:
- The total of one-half of benefits and all other income is more than $34,000 ($44,000 if an individual is married filing jointly).
- You are married filing separately and lived with your spouse at any time during the tax year.
IRS Publication 915 provides detailed information, with examples and worksheets, to help you calculate the tax impact on social security benefits.
Strategies to Help Minimize Taxes
The key to minimizing taxes on social security retirement benefits is reducing MAGI. If you or your spouse still earns wages and cash flow is not an issue, consider delaying your application for social security until your taxable income is lower. Delaying receipt of benefits can increase future benefits by as much as 8 percent per year. In addition, a delay can increase the protection for a surviving spouse.
One strategy for reducing MAGI is investing a portion of your portfolio in a nonqualified tax-deferred annuity. With a deferred annuity, only the increase in the value withdrawn is currently considered taxable and added to the MAGI calculation. Please note: This can be a double-edged sword. When a distribution is taken from an annuity, earnings are taxed at higher ordinary income tax rates, rather than at capital gains rates. Also, beneficiaries don’t receive an increase in tax basis at the annuitant’s death for inherited annuities.
Another approach that may reduce your tax obligation is to draw down a Roth IRA before touching an employer-provided retirement plan or other type of IRA. Qualified Roth distributions are tax free and do not enter into the MAGI calculation. But bear in mind that, to qualify, you must be 59½ or older when the distribution is taken and the Roth distribution must be withdrawn from an account that has existed for at least five years.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Gerard Longo is a financial advisor located at Global Wealth Advisors 2400 Ansys Drive, Suite 102, Canonsburg, PA 15317. He offers advisory services through Commonwealth Financial Network®, Member FINRA / SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors, LLC are separate and unrelated to Commonwealth. Gerard can be reached at (412) 914-8292 or at firstname.lastname@example.org.
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