Who says Congress can’t act quickly when they need to? Just last week they rapidly (after much previous delay) approved budget legislation to narrowly avoid a government shutdown. Unfortunately, buried deep in the pages of that budget—probably somewhere between synchronized swimming studies on Sea Monkeys and a real life iron man suit (actual expenditures in previous budgets)—was a provision that ends two popular and lucrative Social Security claiming strategies. What are the changes to your Social Security claiming options and how will they affect you?
Change #1: Restricted Application for Spousal Benefits
Prior to the change, a person who was eligible for both a benefit based on their own work record as well as a spousal benefit based on their spouse’s work record, could choose to file a restricted application for only the spousal benefit at Full Retirement Age. This would allow their own benefit to continue to grow by earning delayed retirement credits. Then at some future date (as late as age 70), when their own benefit had grown to exceed the spousal benefit, they could switch to the larger benefit. The new law gradually phases out this option.
Those born on or before January 1, 1954 will continue to have the option to file a restricted application for spousal benefits. Those born after that date will not. In other words, if you’re 62 or older by New Year’s Day 2016, you’ll still have the option to file a restricted application once you reach Full Retirement Age (66 for those born between 1943 and 1954). If you’re younger than 62 on New Year’s, it’s Auld Lang Syne for the restricted application option. It should be noted that this change does not affect the ability of widows to file a restricted application for widow benefits and later switch to their own benefit.
Change #2: File and Suspend
Under the old law, there was a strategy called “File and Suspend” whereby a person could file for their benefits, but choose to immediately suspend payment of those benefits. Why would someone do that? The answer lies in the fact that you need to claim your own Social Security benefits before anyone else can claim benefits based on your record. In other words, you need to claim your benefits before your spouse can claim spousal benefits based on your record. But what happens if it makes sense for your spouse to file now, but you want to delay filing so you can continue to earn delayed retirement credits? Enter the “have your cake and eat it too” File and Suspend strategy, which allows your spouse to go ahead and claim benefits on your record while simultaneously allowing you to continue earning delayed retirement credits.
Under the new law, anytime a person suspends their benefit, it will automatically suspend payments to anyone else receiving benefits based on that record. This effectively eliminates the File and Suspend strategy going forward. About the only time it will make sense to voluntarily suspend will be if you change your mind on claiming your benefits and want to suspend payments so you can start earning delayed credits again. The new voluntary suspension rules take effect 180 days after enactment of the new law, which is approximately May 1, 2016.
What actions should you take as a result of these changes? For many people, losing these strategies will mean lower lifetime Social Security benefits, which could mean drawing more from savings or delaying retirement altogether. If you’ve done a Social Security claiming analysis on your own or with your adviser, you should review that analysis to see if the new law warrants a change in strategy. And if you haven’t yet done an analysis, but retirement is right around the corner, now is the time to review your options. The clock is ticking.
As always let me know if there’s ever anything I can do to help. And if you have any questions about the new rules, feel free to post them in the comments section of this article and I’ll do my best to answer them.
When it comes to retirement, your bank account is more important than your birthday. Even so, there are several key retirement ages that you will want to keep in mind as you plan.
Age 50: Once you hit the big 5-0, the government raises the contribution limits on your IRA and 401(k). For those turning 50 in 2013, you can put an extra $1,000 into your IRA and an extra $5,500 into your 401(k). That raises the contribution limits to $6,500 and $23,000 respectively. These “catch-up” contributions can be great if you still have some ground to cover in order to reach your savings goal.
Age 55: If you plan on retiring earlier than most, 55 might be a good target. That’s because there is a provision in the tax code that allows you to take early distributions from your retirement plans at age 55 without paying the usual 10% penalty. These are called 72t distributions and, as you might expect, certain rules apply. Work closely with a trusted adviser if this is an option you’re considering.
Age 59 ½: This is the magic age where the government allows you to start taking distributions from your retirement plans without paying the 10% early withdrawal penalty.
Age 62: This is the earliest date that you can elect to receive Social Security benefits. As I said in a recent article, however, claiming Social Security at age 62 is like buying a pair of leather pants: almost always a bad idea. Claiming at 62 would result in a 25% permanent reduction in your benefits. The longer you wait, the more you will get.
Age 65: This is the age that you become eligible for Medicare. If you’re already receiving Social Security benefits by your 65th birthday, you’ll be automatically enrolled in Medicare. If not, then you’ll need to actually sign up. You will have a 7-month window to enroll: 3 months before your birth month, your birth month, and 3 months after. Sign up in that window, because there are penalties if you sign up late.
Age 66: Most baby boomers can receive full Social Security benefits at age 66. Depending on when you were born, however, you might be able to get full benefits a little sooner or have to wait a little longer. Check here to see when you will be eligible for full benefits.
Age 70: Just like the Social Security Administration reduces your benefits if you retire early, they increase your benefits if you retire late. For those born after 1943, you get an extra 8% for every year you wait past full retirement age up to age 70. After age 70, there’s no benefit for waiting. Said another way, claiming Social Security benefits at 62 will result in the smallest check and claiming at 70 will result in the biggest check.
Age 70 ½: One of the key benefits of your retirement accounts is that they grow tax deferred. Uncle Sam can’t wait forever, though. Congress needs money to fund all those brilliant schemes that they’re always hatching. So at 70 ½ they start forcing you to take required amounts from your retirement accounts each year. Work closely with your adviser to determine your Required Minimum Distributions (RMD), because there is a 50% tax penalty on any amount that you should have taken, but didn’t. The RMD rules don’t apply to Roth IRAs.
Photo by louderthanever. Used under Creative Commons License.
No, you didn’t miss the memo. The government hasn’t announced any plans to cut Social Security. At least not overtly. They have, however (in my opinion), been covertly reducing the value of Social Security payments for years. How?
In order to account for inflation, Social Security payments have a cost of living adjustment built in. If inflation (as measured by the Consumer Price Index) is 3 percent, payments are increased by 3 percent. This works great and everyone is happy, as long as the inflation estimate is accurate. If the government underreports inflation, however, then the raise they give you isn’t enough to offset the increase in prices.
As you may have guessed, many people believe this is happening. There have been several changes to how the government calculates inflation over the years, all of which have had the same affect: To reduce the reported inflation rate. The current Consumer Price Index (CPI) is currently around 2%. Using the methods in place prior to 1990, that number is closer to 6%. Using the methodology in place prior to 1980, that number is closer to 9% (See chart below from shadowstats.com).
I don’t know about you, but when I reflect on my expenses over the last year—property taxes, groceries, cable bill, gas, health insurance—it’s fairly evident that they increased by more than 2%. What if the actual rate of inflation is closer to 6%? How will that affect a person receiving Social Security benefits? It doesn’t take a genius to see that, if inflation is 6% and the government gives you a 2% raise, they have effectively cut your benefits by 4%. If that same pattern repeats itself for 10 years, the purchasing power of your benefits will have been cut by about a third. They are giving you more money, but that money buys less.
Warren Buffet And the Widow
All of this reminds me of a story that Warren Buffett once told about an elderly widow with a passbook savings account.
“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5% passbook account whether she pays 100% income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5% inflation. Either way, she is “taxed” in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120% income tax, but doesn’t seem to notice that 6% inflation is the economic equivalent. If my inflation assumption is close to correct, disappointing results will occur not because the market falls, but in spite of the fact that the market rises.”
Applying that same logic to Social Security, we would find it outrageous if the government cut our Social Security benefits, but seem not to notice that inaccurate cost of living adjustments are the economic equivalent. Disappointing results will happen not because the government cuts our Social Security benefits, but in spite of the fact that they raise them.
The best way to overcome this hurdle is to build your own inflation factor into your Social Security benefits. How do you do that? Rather than waiting until full retirement age or later, the average person retires at 62 and takes a roughly 20 percent permanent reduction in benefits. Rather than following their lead, if you wait a few years you can retire on full benefits. Even better, retire a few years “late” and you can add as much as a third to your annual benefit (8 percent per year for those born after 1943 to a maximum age of 70). The annual cost of living adjustment will likely still be understated, but it will be based on a much higher benefit amount.
Before signing off, I just wanted to make clear that I’m not so much criticizing the Social Security Administration as I am the methodology for calculating inflation. As government agencies go, I’ve always felt that the SSA does a good job with the difficult task that they’ve been given. I know that several people who work for the agency read this blog. If you’re one of them, I’d love to hear your thoughts (pro, con or otherwise) on today’s post so we can all understand this issue better. Just leave a comment at the bottom of the post.
[Note: As most of you know, I’m a financial adviser. I use a program called Social Security Timing to help clients determine the best Social Security strategy for their situation. I’ll run that report for free for the first 20 of my readers (that’s you!) who request it. Certain conditions apply, so just email me if you’re interested (email@example.com).]
Social Security is a major source of income for many retirees. How major? The average retiree gets about 40 percent of their income from Social Security. For older retirees, that percentage surpasses 50 percent. It stands to reason then that we should all want to maximize our Social Security benefits. Here’s how.
You can choose to claim your benefits early, on time or late. “On time” is also known as your full retirement age and it varies depending on when you were born. If you were born after 1960, your full retirement age is 67. If you were born between 1943 and 1954, your full retirement age is 66. Full retirement increases by 2 months per year for those born between 1955 and 1959 (e.g. 1957 = 66 and 6 months).
If you claim early, your benefits will be reduced by 5/9 of 1 percent per month for the first 36 months and 5/12 of 1 percent for anything over 36 months. For example, a person born in 1950 who claims at 62 instead of 66 will see his or her benefits permanently reduced by 25 percent.
If you claim late, your benefits will increase by 8 percent per year for each year you wait (for those born after 1943). So if you want to maximize your Social Security, it’s usually best to wait to claim until on or after your full retirement age. One instance where it might make more sense to claim early would be if you are in poor health and don’t expect to live very long.
If you’re still working and haven’t reached your full retirement age yet, you should think twice before claiming benefits. That’s because your Social Security check will be reduced by $1 for every $2 you earn above $15,120 (for 2013). In the year you reach full retirement age, the penalty is reduced to $1 for every $3 above $40,080.
Unlike the penalty for claiming early, the work penalty is not permanent. It goes away once you reach full retirement age and your benefits will be increased to compensate you for the prior reduction. But that doesn’t really help you if you claim early thinking you’re going to supplement your paycheck, only to have those benefits withheld because you make too much money.
Coordinate with your spouse
When claiming, both you and your spouse have a variety options. Add to that the fact that you are typically entitled to either the benefits you earned yourself or an amount equal to roughly half of your spouse’s benefit and the complexity multiplies quickly. If you can coordinate your claiming strategies, you can greatly increase your lifetime benefits. I have seen couples increase their lifetime benefits by $100,000 or more simply by having a well thought out, coordinated strategy.
Don’t forget your Ex
If you’re divorced and haven’t remarried, you may be entitled to claim benefits based on your ex-spouse’s record. The primary stipulations are that a) you were married for more than 10 years, b) you haven’t remarried and c) you’re older than 62.
So there are a few ideas for maximizing your benefits. Don’t forget to touch base if you want me to run the Social Security Timing report showing you the best strategy for your situation.
Imagine for a moment that you are one of the few lucky people in America still covered by a defined benefit pension plan. Now imagine that you’ve reached the ripe old age of 62 and you’re considering hanging up your work boots (or Wingtips) and heading off into retirement. Your employer would like to see you stick around for a few more years, so he presents you with three options:
1) Retire now and you can start collecting your $1,500 per month pension.
2) Retire four years from now and he will bump your pension up by more than a third to just under $2,000 per month.
3) Stick around for eight more years and he will increase your pension by more than 75 percent to around $2,625 per month.
If only you were so lucky, right? Actually this is more than just a hypothetical. You will likely face a very similar decision as you plan for your retirement, except the “pension” is called Social Security and the “employer” is Uncle Sam.
You will have four basic choices when it comes to claiming Social Security. Three of those were mentioned above: Retire early, retire on time (age 66 or 67 for most baby-boomers) or retire late. The fourth option is called file and suspend (more on that later). If married, your spouse will have the same options.
According to the Social Security Administration more than 73 percent of people start taking benefits early. Should you go with the majority or heed Oscar Wilde’s warning that “Everything popular is wrong.”? It depends.
Your goal should be to choose the option or combination of options that will result in the greatest cash flow for you and your family. Generally speaking, the longer you wait, the higher your benefits will be, but waiting isn’t a given. Below are several questions to consider that will help you evaluate when to file.
Are you still working?
If you are still working and you decide to begin receiving Social Security benefits early, chances are good that your benefits will be reduced. If you earn more than the earnings limit ($14,640 for 2012), your benefits will be reduced by $1 for $2 you make above the limit. That penalty shrinks in the year that you reach full retirement age. This is more of a delay than a permanent reduction. Once you reach full retirement age, the earnings penalty goes away and Social Security will recalculate your benefit amount to credit you for the months you were penalized. Still, if your plan is to file early in order to supplement your income, you may have less coming than you thought.
Do you have a long life expectancy?
Some people spend only a few years in retirement, while others spend decades. Consider the life expectancy of both you and your spouse. If you are healthy and expect to be collecting benefits for a long time, it might benefit you to delay filing for Social Security until you have accrued the maximum benefit. Alternatively, if your health is poor, you might consider collecting benefits as soon as possible, unless your spouse is healthy and is relying on your earnings history (spousal benefits allow your spouse to either claim their benefit or half of yours, whichever is greater). In that case, if you file early and receive reduced benefits, your spouse will be stuck with those reduced benefits for the remainder of his or her life. Be sure to consider how your actions affect your spouse’s benefits and vice-versa.
Will you have health insurance?
You can begin collecting Social Security benefits as early as age 62, but you won’t be eligible for Medicare until 65. It’s not a good idea to be without coverage, so make sure you have a plan to replace your employer provided health coverage if you decide to retire early.
Do others qualify for benefits based on your earnings record?
If someone is filing based on your benefits, when you choose to file will affect the benefit that they receive. If you choose to file early and take a reduced benefit, any person filing based on your record will take a reduced benefit as well. The decision that maximizes your lifetime benefits might drastically reduce those of your spouse. Keep that in mind.
Do you qualify for benefits on someone else’s record?
If your spouse or former spouse has died and you qualify for survivor benefits based on his or her earnings history, it could make sense to apply for those benefits now and wait to claim your own retirement benefits until later, when they are higher.
If your spouse is still living and has reached full retirement age, it might make sense for him or her to employ a file and suspend strategy. Here your spouse would file for benefits, but ask the Social Security Administration to suspend the payment of those benefits. Because you can’t file for benefits on their record until they do, this would allow them to continue earning delayed retirement credits, but would also allow you to file for spousal benefits.
Where will you get more growth?
Your Social Security benefits will be about 75 percent higher if you wait until 70 to collect as opposed to 62. That’s a compound rate of growth of more than 7 percent per year to your benefits. Can you get a better rate of return with your personal investments? Certainly not with a money market or certificates of deposit whose rates are at multi-decade lows. You might be able to get that kind of growth in stocks, but not without added risk. My point? If your benefits are growing faster than your personal investments, it might be better to tap your nest egg first and wait to take Social Security until later.
Thankfully, there are many tools available to help you evaluate your options. To analyze your personal situation and get ideas for how best to maximize your benefits, use the Social Security timing calculator at www.intentionalretirement.com/social-security. No matter what you ultimately decide, be sure to consider your options carefully. Your choice will likely be one of the most important decisions you will make when it comes to your retirement.
I met with a prospective new client this week and he asked me the question I get asked by most people during introductory meetings:
“When can I afford to retire?”
We spent about an hour working through some numbers and coming up with the answer. I thought seeing a real world example would be helpful to some of you, so I asked him if I could share the details as long as I kept his name confidential. Here are the basic facts:
He and his wife are 61 years old
He has worked for his current employer for 41 years
His 401(k) is worth around $700,000
They have another $600,000 in savings and investments
His estimated Social Security benefits are $1,900 per month if he retires early at 62 and $2,500 per month if he waits until full retirement age at 66.
His wife does not work outside the home and has not qualified for Social Security
Their house is paid for and they have no other debt
They need an income of $60,000 per year in retirement
Step 1 in deciding when to retire is answering the question “How much income do I need?” As George Foreman said, “The question isn’t at what age I want to retire, it’s at what income.” In this case, the client (Let’s call him Jim) wants to have about $60,000 per year gross (i.e. Before taking out taxes).
Step 2 is figuring out where that money is going to come from. If Jim retires at 62, he will get $1,900 per month from Social Security. That’s $22,800 per year. He wasn’t expecting his wife to receive any Social Security because she hadn’t worked the 40 quarters required to qualify. Needless to say, he was happy when I told him that she qualifies for a spousal benefit. Spouses are entitled to receive the higher of their benefit (in this case $0) or half their spouses benefit (in this case $950 per month). That adds another $11,400 in income per year.
So they need a total of $60,000 and $34,200 of that is coming from Social Security. That means their personal investments will need to generate the remaining $25,800. Is their nest egg up to the task?
They have a total of $1,300,000. As we have discussed here many times before, research shows that a safe withdrawal rate from a portfolio is around 4 percent. Taking a 4 percent withdrawal from their portfolio would get them about $52,000 per year, which more than covers the $25,800 they need. So looking at the numbers, Jim and his wife could afford to retire at 62. But should they? I advised him to seriously consider waiting a few years. Here’s why:
They will almost certainly need more income than they are expecting. Jim told me that his $60,000 estimate is the absolute minimum they’d need to maintain their lifestyle. If anything unexpected happens and they need to draw more, they could run out of money sooner than expected.
They are both in good health and have parents that are alive and in their nineties. Given their health and family history, there’s a good chance that they will live for a long time. If that’s the case, their money needs to last. Working for a few more years not only gives them a chance to save more, but also means that they won’t be drawing income from their savings yet, which will help it last longer.
The breakeven point on their Social Security (where it makes sense to wait until full retirement age to claim benefits) is about 12 years. That means if they plan on living past age 74, it probably makes sense to wait to begin collecting benefits until full retirement age rather than taking a reduced benefit at 62.
Another potential reason to wait is health care. Right now, Jim’s employer pays the cost of his health care, but that would stop if he retires. Since he and his wife won’t be eligible for Medicare until age 65, retiring now would mean either going without health care or paying out of pocket for coverage. To continue his current coverage using COBRA would be about $900 per month. Waiting to retire until they are eligible for Medicare would eliminate that expense.
Finally, we’re living in an uncertain time. Inflation is tame now, but could easily get much worse. The markets are volatile. Interest rates are low. All of these things can damage a portfolio’s ability to generate enough income.
Conclusion: Jim and his wife can afford to retire now, but as long as they’re in good health and Jim is relatively happy at his job, waiting could greatly increase their security during retirement. I hope that example helps shed some light on the process of deciding when you can afford to retire. Touch base if you have any questions or if there’s ever anything I can do for you.