Making Smart Social Security Decisions to Boost Your Financial Security
/As you approach retirement, there may be financial decisions you wish you could go back and redo. Saving more. Starting earlier. Investing in a diversified index fund instead of Enron. Asking for that raise. The list goes on and on.
While you can’t change your past financial decisions, there’s one very important decision you can still get right. That decision is when to claim social security.
Why Is It So Critical to Get Social Security Right?
Social security is the best longevity insurance for most individuals.
Not only does it pay you income for the remainder of your life, but the income paid rises with the cost of living. In addition, social security has tax-favorable treatment in most states. For married couples, it will often be the main source of income for a surviving spouse after the first spouse passes.
In most cases, your social security income is deemed fully available at age 66 or 67, depending on your birth year. After that, it grows an additional 8% for every year you wait to claim up until age 70. You’re eligible to claim as early as age 62. Unfortunately, this is when mistakes are often made.
For a dual-working married couple with decent earnings over a lifetime, waiting until 70 can be the difference between receiving $55,000 instead of $75,000 each year. Once you factor this over twenty years, the incremental dollars really add up!
For the typical American household, the value of social security represents 60% of retirement assets.1.
Longevity Insurance Provides Long-Term Income
It’s important for you to think of social security as your key longevity insurance. Yet you may have false notions about the program, such as:
· I can’t retire until I start social security. (Pensions, investments, and other savings can be applied to cover expenses until your optimal claiming age.)
· I’m afraid the government will take this away. (This has never happened since the program began in 1935.)
· I probably won’t live past the break-even age of 802. (The average life expectancy for those who have reached age 60 is 85.3 A 65-year-old couple has a 45% chance — almost 50/50 — that one of them will survive to age 90.4)
· I want to start social security early so I can invest the extra money. (Despite good intentions, most people won’t do this.)
Social security is longevity insurance, plain and simple. It offers protection against running out of money as we age. People rarely do break-even calculations when they buy home insurance to protect against a catastrophic event like a fire. They shouldn’t do them with social security either.
Inflation-Adjusted Benefits Help You Retain Your Purchasing Power
Unlike many annuities that are sold as “longevity insurance,” social security increases based on a consumer price index each year. This annual adjustment has been in place since 1975. In recent years, the increase has ranged from 1–2%. However, for 2022, the increase is on track to be about 4–5%.
This means you won’t lose purchasing power with this part of your retirement income. For a retirement that can last over 30 years, this is a very big deal! As one financial advisor said to me once, “My annuity payment looks pretty good now, but I doubt it will even buy a movie ticket for me in my 90s.” With your social security income, it will keep you on track to enjoy movies and more.
Favorable Taxation Keeps More Money in Your Pocket
At the federal level, each dollar of social security paid is not taxed completely. Depending on your income, anywhere from 15–50% of the income received will not be taxable.
Forty-one states, including California, give tax-favorable treatment to social security income. In fact, in California, social security income is not taxed at the state level. I know what you’re thinking: “Wow! A tax break in California.” Yes, miracles do happen.
Even in states that do tax social security (Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia), there’s usually a tax credit or deduction that offsets the cost of the tax.
Financial Security for the Surviving Spouse
Once a spouse passes, the surviving spouse loses one of the social security incomes. They do, however, get to keep the income that is the higher of the two social security incomes paid out. If your spouse pre-deceases you at an early age, this can be a really big deal! No one anticipates losing their spouse or a chunk of their income at 75, but it does happen. In many cases, it leaves the surviving spouse feeling much poorer.
For example, a woman I know was married to a doctor who passed away at 69. The social security benefits that would ultimately flow to the wife were seriously compromised in two ways. During the doctor’s working years, the doctor minimized W2 income like many business owners are encouraged to do in order to minimize payment into the social security system. Then, upon retirement, he decided to fire up his social security benefits at 62, the earliest age possible. As mentioned previously, this reduced his social security income by over 8% per year between ages 62 through 70. (Important note: spouses claiming spousal benefits do not get increases after their full retirement age of 66/67)
The end result was that the wife had to figure out how to manage on a much tighter budget than expected. It is very rare for me to see a client whose social security won’t cover their core living expenses like housing, utilities, and food. In this case, the surviving wife was left with a suboptimal income.
Optimizing Your Social Security Benefits
As a professional who has reviewed hundreds of social security claiming scenarios, I believe the best way to calculate the optimal claiming strategy is to use social security optimizer software. My favorite is Social Security Analyzer because it does an excellent job keeping up with the legislative changes in social security claiming options.
While it often makes sense for at least one person in the household to wait until age 70 to claim social security benefits, there are several situations where claiming early might be a smart move. A couple of examples include having a disabled child claiming through you or being single and in poor health.
The software may also identify a welcome situation. I have worked with divorced clients who learned they could surprisingly claim benefits on their deceased ex-spouse while letting their own benefits grow until 70.
Ultimately, deciding when to claim social security should be made within the context of a retirement plan, ideally assembled by a certified financial planning professional who is doing the analysis with your best interest at heart. In addition to enhancing benefits, delayed claiming can open up the opportunity to do Roth IRA conversions in the years preceding social security.
The unfortunate truth is that many Americans mismanage their social security income. Considering that it’s often your largest retirement asset, this decision can have dire costs for both you and your spouse. Before you claim social security, be sure to take the time to get an appropriate analysis done so you can set yourself up for success in your retirement years.
For help devising your social security strategy, give me a call or send me an email. I’m happy to answer any questions you may have.
Sources:
1. Templin, Neal. (May 9, 2021). “The Biggest Mistakes People Make With Social Security.” The Wall Street Journal. Retrieved from https://www.wsj.com/articles/the-biggest-mistakes-people-make-with-social-security-11620561601.
2. Peterson, Jonathan. (2015). “How to Perform a Break Even Analysis for Your Social Security Benefits. “Dummies. Retrieved from https://www.dummies.com/personal-finance/retirement-options/how-to-perform-a-break-even-analysis-for-your-social-security-benefits/.
3. Social Security Administration. (2019). Period Life Table, 2019. Retrieved from https://www.ssa.gov/oact/STATS/table4c6.html .
4. Vernon, Steve. (June 24, 2013). “Living Too Long Is a Risk!” CBS News (Money Watch). Retrieved from https://www.cbsnews.com/news/living-too-long-is-a-risk/.
