Retirement Planning: A Primer on Social Security Benefits

social_security_626Social Security benefits represent an important, but often overlooked, component of retirement income planning. As a source of guaranteed income that cannot be liquidated, it is not often thought of as an asset. In fact, it is the single largest financial asset for many retirees, providing benefits for approximately nine in ten individuals age sixty-five and older and covering ninety-six percent of working-age adults.

The importance of Social Security benefits cannot be overstated, but the program is based on a Byzantine set of provisions that make it challenging to fully understand. In this week’s blog post, we will provide a framework for understanding the program and its various benefits, and point out some of the most common gotcha provisions to look out for. Our follow up post will expand on the basics to include a discussion on retirement benefit claiming strategies.

The Social Security Act was signed into law on August 14, 1935 by Franklin Delano Roosevelt as part of the New Deal. The legislation established a system to provide Federal old-age benefits, and provisions to care for the country’s most vulnerable citizens. The act was later amended to establish the Medicare system. Social Security has a total of four trusts that are used to fund the program’s various benefits.

  1. Old-Age and Survivors Insurance Trust (OASI).
  2. Disability Insurance Trust.
  3. Hospital Insurance Trust Fund (Medicare Part A).
  4. Supplementary Medical Insurance (SMI) Trust Fund (Medicare Parts B and D).

The program is funded by Social Security taxes of 12.4% on earnings up to the prevailing maximum taxable earnings limit of $118,500 (2015), and is evenly split between employees and employers. Medicare is also funded by a tax on earnings of 2.9%, with the burden divided evenly between employees and employers. Unlike Social Security taxes, however, Medicare taxes are not subject to an earnings maximum.

Social Security retirement benefits, the primary focus of this article, represent the sole source of  income for twenty percent of Americans over age sixty five, and more than half of the retirement income for two out of three current retirees. The sharp decline in the availability of employer pension plans and increases in human longevity makes it unlikely that these ratios will change materially over time. Despite its critical role in the retirement plans of most Americans, changes to the program are inevitable, as the 2014 annual reports from Social Security and Medicare Boards of Trustees makes clear:

“Neither Medicare nor Social Security can sustain projected long-run program costs in full under currently scheduled financing, and legislative changes are necessary to avoid disruptive consequences for beneficiaries and taxpayers.”

While the OASI trust is projected to remain solvent through 2033, and will retain the ability to pay three fourths of projected benefits thereafter, the Medicare trust funds are projected to run out of money in 2030. The disability trust fund  is on particularly shaky ground and could become insolvent in late 2016.

Proposed changes run the gamut and include reductions in benefits, an increase in the retirement age, and changes to how the cost of living increase for retirement benefits is computed. A consensus has yet to be reached, however, it is widely expected that changes to the program would occur over time and have little or no impact on those in or nearing retirement.

Social Security retirement benefits are paid to those individuals that have accrued ten years or more of qualifying work. Benefits are calculated using the highest thirty-five years of wage history, with earnings prior to age sixty being indexed for wage inflation. In cases where an individual worked less than thirty five years, zeros will be used in the computation of benefits for those years where no wage history is available. Thus, individuals with gaps in employment may materially increase their benefits by working longer to offset the years with low or no earnings. The resulting retirement benefit is referred to as one’s Primary Insurance Amount (PIA), and is the foundation on which all benefits are calculated.

When benefits are paid is another important component of the calculation. The PIA is the amount paid to a retiree when they attain their Full Retirement Age (FRA), as defined below, however, reduced retirement benefits are available as early as age 62, and survivor benefits may begin at age 60 (age 50 if disabled, and younger still if caring for children under age 16). Reductions in Social Security survivor benefits follow a different schedule than detailed below.

Year of Birth                                                             Full Retirement Age

1943-1954 66 years
1955-1959 Add two months per year
1960 and later 67 years

The reduction applied to Social Security retirement benefits and spousal benefits is equal to 5/9 of 1% for each month prior to FRA, for the first 36 months, or approximately 6.67% per year. Additional months are reduced by 5/12 of 1% per month. Thus, someone with an FRA of 66 years that begins collecting benefits at age 62 would see a permanent reduction in their benefits of approximately 25%. It is also important to note that retirement benefits collected prior to FRA are reduced by $1 for every $2 of earnings that exceed the Social Security Earnings Limit ($15,720 for 2015).

While Social Security benefits are reduced when claimed prior to FRA, they may be eligible for delayed claiming credits of 2/3 of 1% per month, or approximately 8% per year from FRA until age 70. In addition, any cost of living increase awarded during this period of deferral is credited,  and retirees receive future cost of living adjustments on a higher benefit amount. This combination creates a strong incentive to delay the collection of  retirement benefits. It is important, however, to point out that only Social Security retired worker’s benefits are eligible for this increase, spousal retirement benefits are not.

Classes of Benefits:

Retired Worker’s Benefits:  based on earnings history and may be collected as early as age 62, or deferred until age 70.

Spousal Benefits: benefits that one spouse receives based on the earnings record of the other spouse. In general, the benefit is equal to 50% of the retired worker’s primary insurance amount at their full retirement age. Reduced benefits are available as early as age 62 and benefits are not eligible for deferred credits. There are a few gotcha provisions that relate specifically to spousal benefits.

  • Both spouses cannot receive spousal benefits at the same time.
  • In order to receive spousal benefits, the other spouse must have filed for their benefits. They may “suspend” payment of benefits and continue to earn deferred credits on their retired worker’s benefits- e.g., a husband may file for his worker’s benefits at his FRA so that his wife can file for spousal benefits based on his PIA.
  • Full Retirement Age for spousal benefits is based on the age of the recipient of benefits.
  • An application for spousal benefits made prior to full retirement age is subject to the “Deemed Filing Rule.” This gotcha provision mandates that applicants under FRA that apply to receive benefits have been deemed to apply for all benefits for which they are entitled. This may result in an unintended application for retired worker benefits.
  • Applicants that have attained FRA have the ability to select the specific benefit for which they are applying.
  • Spousal benefits end at death, at which time a spouse collecting spousal benefits would become eligible to collect survivor benefits.

Survivor Benefits:  benefits that a surviving spouse receives after the death of their spouse. The benefit is based on the deceased spouse’s PIA and includes any decrease or increases in the PIA based on an early or deferred filing.

  • If the spouse dies after starting their Social Social benefits, the survivor benefit is usually equal to the deceased spouse’s monthly benefit.
  • If the spouse dies prior to starting their Social Security benefits, the survivor benefit is usually equal to the deceased spouse’s PIA. Note that the PIA may be lower than estimated due to the replacement of projected future earnings with zeros.

Divorced Spouse Benefits: benefits that a divorced spouse, married for ten years or more, receive based on the earnings record of their former spouse. As with spousal benefits, there are some unique rules that apply to divorced spouse benefits.

  • Divorced spouses may qualify for spousal benefits and survivor benefits based on the earnings record of their former spouse.
  • Eligibility for benefits generally ends upon remarriage. In other words, you must be single to receive benefits. An exception is that those that remarry after age 60 continue to qualify for survivor benefits based on the earnings of their former spouse.
  • Spousal benefits do not require the former spouse to file for benefits, reduced benefits may be claimed as early as age 62.
  • Divorced spouse benefits are paid in addition to any benefits paid to the current family. This presents a unique planning opportunity for divorcées that we will discuss in our next blog post.

Social Security is an integral part of the retirement plan for most Americans, yet many receive little practical advice on claiming their benefits. A poor decision is difficult or impossible to correct and may result in large, permanent reductions in retirement income. In our next blog post we will address several common, and not so common, benefit claiming strategies and discuss how those benefits are taxed. We hope this discussion provides readers a useful context to evaluate their own benefits, and we welcome any comments or feedback.

John Male, CFP®
The Gassman Financial Group
G&G Planning Concepts, Inc.
The Retirement Maven ™
9 East 40th Street, Suite 1500
New York, NY 10016
Tel: 212-221-7067 Ext. 17
Fax: 585-625-0830


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