Claiming Your Social Security
Good Morning Relaxing Retirement Subscriber,
If there is a subject that generates a lot of confusion and questions, it’s social security.
There’s a good reason for that: it’s complicated and the rules have changed over the years, especially with respect to spousal benefits.
Given this, I’d like to walk you through a quick case study and clarify the key points to focus on when deciding how to claim your benefits, and benefits for your spouse.
Let’s assume for a moment that Bill and Sue are both age 64 and their first question is, “should we start collecting social security now, or wait until age 66?”
There are 2 major factors to consider before collecting social security benefits before your ‘full retirement age’ (66.2 years of age today).
Factor #1: Earnings Limit
The first is your earnings limit.
When you reach “full retirement age”, you can earn as much as you want from work (earned income) and still receive your full social security benefits without any reduction in benefits.
Only income you receive from work, whether that income is reported on a W-2 or 1099, is counted for social security income calculation purposes,
Income you receive from pensions, rental property, dividends and interest, and capital gains do not factor into the equation.
Between age 62 and your full retirement age, social security limits the amount you can collect depending on how much other income you earn.
From age 62 to 65, you lose $1 of social security benefits for every $2 of “earned” income over $16,920 (in 2017). That’s $1,410 per month.
During the year in which you reach full retirement age (66.2 years today), you lose $1 in benefits for every $3 he earns in excess of $3,740 per month/$44,880 per year.
Factor #2: The Math
Factor #2 is the “math”. In other words, is it worth it to wait until Bill and Sue turn 66 to begin collecting, or are they better off starting right now at age 64?
For the sake of the example I’ll use here today, let’s assume for a moment that Bill and Sue are actually age 62 (not 64) as that is the age at which Americans may now begin receiving social security retirement benefits.
Bill’s social security benefits statement shows that his monthly benefit at age 66 will be $2,500 per month. And, if he begins collecting at age 62, his benefit will be $1,875 per month (75% of his age 66 benefit).
If Bill starts collecting now, he’s going to take a 25% pay cut! That doesn’t sound too great, does it?
However, he really needs to take a look at the math for a moment:
- Monthly Benefit at age 66 (if he waits) $2,500
- Monthly Benefit at age 62 (today) $1,875
If he takes his benefit today, Bill is going to receive $625 less per month.
If they decide to wait until Bill reaches age 66, what they’re really saying is that it’s worth it to wait 4 years (or 48 months) to get the extra $625 in the 49th month and beyond.
However, an intelligent question to ask is “what are they giving up by waiting?”
What they’re giving up is 48 months (4 years from age 62 to age 66) of social security benefits. That’s $90,000!
Not an insignificant number.
The “Break Even” Age
In order to recoup that $90,000 that they would give up by waiting until age 66, Bill would have to live another 144 months after age 66, or 12 years, at which time he’d be 78 years old. ($90,000 divided by the incremental increase of $625 at age 66 = 144 months)
So, in order to break even, Bill and Sue would have to live another 16 years (4 years from age 62 to 66 + 12 years = Age 78).
And, this doesn’t take into consideration 3 other factors:
- Bill and Sue will likely receive a cost of living increase each year on their social security benefits, so their benefits will begin increasing after their first year of collecting.
- If Bill and Sue begin collecting at age 62, they could invest their monthly check and potentially earn even more.
- Finally, and this is the most important factor in maintaining their lifestyle sustaining income over the rest of their lives, if they don’t draw from social security right now, they must draw income from some other source, i.e. their Retirement Bucket™. Delaying social security reduces their inflation fighting investments more rapidly.
And, if the majority of their Retirement Bucket™ is in IRAs or other retirement plans, it may potentially reduce them even faster because they have to pay income taxes on 100% of what they withdraw vs. a maximum of 85% of their social security income.
Other Factors To Consider
While Bill and Sue’s example should give you a good guideline to use, here are some other factors which may affect your own unique situation:
- Life Expectancy: If you have health issues that are predicted to shorten your life expectancy, clearly this should lead you to collect benefits as early as you can get them.
However, if everyone in your family has lived well into their 90s, this may pull you in the opposite direction.
- Severance: If you’re collecting severance pay from the employer you’re retiring from, this may alter your desire to begin collecting right now because of the taxes you’ll pay on your social security benefits while you’re also receiving large severance pay.
- Deferred Compensation: This same principle applies to deferred compensation. Let’s say that for the 5 years prior to your retirement, you’ve contributed to an executive ‘deferred compensation’ plan. If the plan calls for you to receive a payout immediately upon retiring, as many of our members do, this may have adverse tax consequences on your social security benefits.
- “Other” Income: If you have other “locked in place” income, you have to weigh the after-tax benefits of collecting social security benefits early.
This dovetails into a major principle that I recommend, and that is to never make any decisions concerning benefits or investments without also simultaneously considering the tax consequences.
This is a monumental mistake that I see in the overwhelming majority of situations.
As you can see, there are several factors that go into your decision. Hopefully, this example provided a good line of questions for you to answer in your own unique set of circumstances.
Next week, we’re going to continue our discussion by clarifying all options for your spouse because benefits collected by working and non-working spouses vary greatly if you don’t know the rules.
Committed To Your Relaxing Retirement,
The Retirement Coach
P.S.: WHO do you know who could benefit from receiving my Retirement Coach “Strategy of the Week”? Please simply provide their name and email address to us at info@TheRetirementCoach.com. Or they can subscribe at www.TheRetirementCoach.com.
I appreciate the trust you place in me. Thank you! (The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)