Factors to consider when claiming Social Security
If you are nearing retirement one of the most difficult decisions to make is when to apply for your Social Security benefits. This is not surprising with some 95% of current retirees stating that Social Security benefits are important to their monthly income. There are hundreds of claiming strategies to consider and thousands of governing rules. Not to mention the conflicting and outdated advice that is floating around. Many people simply start taking benefits as soon as they can – at age 62 – and for some that is the right decision. For others, however this can have an immense negative impact on their overall financial plan.
There is not one right answer on when to start taking your benefits but there are factors to consider before making an informed decision. We will cover some of those important factors in this paper but first let’s review some of the facts regarding Social Security.
You are eligible for Social Security benefits (throughout this article we are referring to retirement benefits only) after having at least 40 quarters – 10 years – of reported earnings. During that time you have been paying Social Security taxes, along with your co-workers, which is set aside to be paid out later in benefits. To get an estimate of how much your benefit will be you can use one of the many online calculators and enter your wage information, or for a more accurate reading you can get an estimate from the Social Security Administration.. Either method is basing your benefit on the highest 35 years of your recorded earnings.
Once you have your estimate there are three age milestones which we can use to discuss the timing of benefits. They are:
- Age 62 – is the earliest in which you can receive benefits. This is the same for all claimants.
- Full Retirement age – depending on your date of birth this is the age you receive 100% of the benefit you have earned.. Anyone born in 1960 or later this is age 67. (see Table 1)
- Age 70 – this is the age in which you will receive the highest maximum dollar benefit. There is no advantage to claiming after age 70 as your benefit will not increase.
You can start taking benefits at any age from 62 forward but how long you wait will determine your benefit amount.. If you start taking Social Security before your Full Retirement age, your benefit will be reduced by about 6% a year. If you begin taking benefits at age 62 when your Full Retirement age is 67, you’ll receive about 70% of the monthly benefit you earned (and could collect if you wait until you are 67). The difference between taking your benefits at age 62 and waiting until later can mean thousands of dollars in benefit income.
If you delay your benefit even further, after your Full Retirement age, your benefit will increase by 0.67% a month, which is an 8% increase for each year you delay your benefit past your Full Retirement age. As we mentioned there is no increase in benefits past the age of 70.
When you claim benefits from age 62 to 70 is a critical decision affecting your long-term retirement plan.
Questions to ask yourself
So now that you know the general rules for Social Security benefits – the longer you wait the higher your benefit – how do you decide the best time for you to claim benefits. Every person’s financial situation is unique but here are some factors to consider when making this decision.
What is the life expectancy for you and your spouse? This matters the most in determining the best time to collect Social Security, but of course, it is the most unpredictable factor. If we could perfectly predict how long we would live we would simply claim benefits at the time that would give us the maximum dollar amount. For example, if we knew we would not live past 72 there would be no reason to wait to claim benefits past age 62. 10 years of benefits at a lower dollar amount will outweigh any benefit from claiming later.
In working with clients through Social Security claiming strategies there is a “break even” analysis that can be done which shows you how long you would have to live to make up for delaying benefits. If you waited until age 70 that is usually going to be around 12 to 13 years, which is not an uncommon age for at least one spouse to live until given longer life expectancies.
Even though your life expectancy is unpredictable you can make an informed decision based on your overall lifestyle, health and family history. If you have a good family medical history and you have a healthy, active lifestyle it would make sense – if you can – to delay taking benefits so that you receive more later in life. Having an honest conversation with your family can help decide at what age you should start collecting benefits. As we will discuss later, an important part of this discussion is the realization that Social Security benefits end at the death of the second spouse. Heirs will not inherit that income stream.
Will you be relying on Social Security benefits to meet other expenses? As we already mentioned Social Security benefits are very important to retirees to meet ongoing living expenses. Once you leave your job the income spigot is cut off and you have to rely on other sources of income like pensions, investment income, investment capital and, like most people, Social Security benefits. If you are fortunate to be able to meet or exceed your living expenses from other sources, it would be wise to delay taking benefits so that you can maximize the dollar amount you would eventually receive. Of course, there may be a shortfall between your other income sources and your living expenses and that gap can be filled with Social Security benefits.
I recommend people spend some time to really understand their cash flow needs and with that information you can better decide whether to take benefits early or to delay.
You never want to make financial planning decisions based solely on having to pay taxes but when it comes to Social Security it is a factor to consider. Here is why. In determining taxes for retirees the IRS measures your provisional income to decide if you are required to pay taxes on your benefits. It is calculated by adding your adjusted gross income, any tax-free interest you received and 50% of your Social Security benefits. If this number is over a designated threshold (see Table 2) your Social Security benefits could be taxed 50 – 85%.
Today many people retire with multiple investment accounts in the form of 401ks and IRAs. If you will be withdrawing money from these accounts you may want to delay – and receive a higher monthly benefit later – your Social Security to avoid a larger tax bite. Remember once you go above the designated threshold your benefits would be taxes. This is only if you have the investment funds that can support your living expenses during the “gap years” (the years between retirement and when you begin to collect benefits) without drawing out too much.
Social Security can be used as an estate planning tool if you have a desire to leave your children, a charity or other heir some money upon your death. Remember your heirs do not inherit the income stream of Social Security so you may consider taking your benefits earlier and leaving other funds to grow inside your investment accounts – which they can be inherited as part of an estate. Another strategy would be to use the benefits to purchase life insurance or make 529 college savings contributions for the grandkids. This, of course, is only after all your current and expected living expenses are covered and your nest egg is large enough to sustain your retirement living expenses.
How do you make the best decision for you and your family? If you have read this far you know it is one that is influenced by many factors and, unfortunately, there is no one right answer. If you need Social Security benefits to help cover living expenses right at retirement then you need to claim as soon as you can. If that is not the case you should consider the factors we discussed: life expectancy, taxes and your desired legacy.
With the difference in lifetime benefits based on different strategies being in the thousands of dollars, it is wise to seek competent advice. To that end, if you have any questions or would like to have a detailed plan and strategy report built for your specific Social Security benefits, feel free to schedule a complimentary call. A convenient time can be scheduled here.
Table 1 – Full Retirement age based on birth year
|Birth Year||Full Retirement age|
|1943 – 1954||66|
|1955||66 + 2 months|
|1956||66 + 4 months|
|1957||66 + 6 months|
|1958||66 + 8 months|
|1959||66 + 10 months|
Table 2 – Provisional Income levels for taxable benefits
|Married Filing Jointly||Single|
|0% Taxable||< $32,000||< $25,000|
|50% Taxable||$32,000 – $44,000||$25,000 – $34,000|
|85% Taxable||> $44,000||> $34,000|
Everyone’s financial situation is unique so this should be considered a starting point for conversations and further planning. This is not intended as tax or investment advice.