Social Security benefits provide the foundation that most Americans will rely on in retirement, and decisions related to the claiming of benefits can have a profound impact on retirement income and overall quality of life. Despite the heavy reliance on Social Security- it provides over 90% of the retirement income for one in three recipients-less than 5% of seniors avail themselves to strategies designed to maximize their benefits.
Effective claiming strategies may be quite simple in certain cases, and rather complex in others. A basic understanding of Social Security benefits and how they are calculated can help you determine whether you can go it alone, or if expert guidance is called for. This article will explore some common, but distinct, scenarios and the claiming considerations associated with each.
Scenario 1: Married couple ages 66/64 with a wide gap in benefits and a normal or long life expectancy
- Social Security retirement income can be materially increased by maximizing delayed retirement credits. A high-earning spouse should strongly consider delayed filing if their spouse’s retirement benefit is materially lower.
- Social Security surviving spouse benefits help protect a spouse that has earned a smaller retirement benefit. Maximizing this survivor benefit is an important consideration when there is a large gap in retirement benefits.
- Those born on or before January 1, 1954 can avail themselves to a restricted filing for Social Security spousal benefits, thus making a strategy of delayed filing less burdensome.
In the case where the lifetime earnings of one spouse far exceed those of the other, or where one spouse has not met the qualifications for Social Security retirement benefits, maximizing the retirement benefits of the higher-earning spouse is crucial. This not only increases their Social Security retirement benefit, but provides the basis for Social Security surviving spouse benefits. To accomplish this objective, the higher-earning spouse should generally defer collection of their Social Security retirement benefits to maximize their delayed retirement credits.
To illustrate, let’s take a married couple ages 66/64 that each qualify for Social Security retirement benefits under their respective earning record. The higher earning spouse has a primary insurance amount (PIA) benefit of $2,000 per month at full retirement age, while their spouse’s PIA is $800. Assume that the higher-earning spouse lives to age 83 and their spouse to age 85, and that their benefits are subject to an average cost of living adjustment of 2.5% per year.
The most critical component of the recommended filing strategy in this scenario is for the higher-earning spouse to defer collecting their benefits to earn delayed retirement credits. Strategic decision making will focus instead on when the lower-earning spouse should collect their benefit.
One option is for lower-earning spouse to file for their own Social Security retirement benefits at age 64, which opens up the opportunity for the higher-earning spouse to file a restricted application for Social Security spousal benefits while deferring their retirement benefits. Although the lower-earning spouse will have their Social Security retirement benefits reduced by 5/9 of 1% of their PIA amount for each month that benefits are paid prior to their full retirement age, and their benefits may be subject to income-based benefit reductions, the spousal benefits collected by the higher-earning spouse may offset these reductions. Using the assumptions detailed above, the resulting lifetime cash flow under this claiming strategy is $940,524.
Another option is for the lower-earning spouse to wait until they attain their full retirement age before claiming their Social Security retirement benefits. The higher-earning spouse will have to wait an additional two years to collect Social Security spousal benefits, but the lower-earning spouse will receive their full PIA and will not be subject to income-based benefit reductions.
The difference between the two strategies in this case was additional lifetime cash flow of $3,438 by electing the first claiming strategy. This early benefit collection strategy is best suited if the lower-earning spouse’s wages are low enough to avoid the income-based benefit reduction. The net gain in this case, however, is minimal and in many cases it may be wise for both spouses to reach full retirement age prior to filing for benefits.
What if: the low-earning spouse did not qualify for Social Security retirement benefits?
In a case where the low-earning spouse did not have enough Social Security retirement credits to qualify for benefits under their own employment record, they would instead collect Social Security spousal benefits based on their spouse’s PIA.
To maximize lifetime benefits in this scenario, the higher-earning spouse would defer their Social Security retirement benefits, but only until age 69. The lower-earning spouse would then become eligible to collect Social Security spousal benefits. Remember that in this case the higher-earning spouse must claim their own retirement benefits in order for their spouse to become eligible to collect spousal benefits. In the case of eligible divorced spouses, there is no such requirement. This strategy resulted in lifetime income of $908,460.
The result in this case was curious in that the high-earning spouse did not take full advantage of their delayed retirement credits by deferring their Social Security retirement benefits to age 70. This outcome is a function of the mortality assumptions used in the modeling. An additional year of assumed life expectancy would have altered the optimal strategy slightly, resulting in the higher-earning spouse further delaying their retirement benefits until they have attained age 70. This example illustrates the importance of testing the inputs used in your model.
What if: the low-earning spouse does qualify for Social Security retirement benefits and the age of the spouses is reversed to 64/66?
In this case, merely reversing the ages of the spouses does not have a material impact on the recommended claiming strategy. To maximize lifetime income, the lower-earning spouse should file a claim for their Social Security retirement benefits at age 66, thus allowing the higher-earning spouse to file a restricted application for spousal benefits upon attaining their full retirement age. The higher-earning spouse will defer their own Social Security retirement benefits until they attain age 70. The net result is lifetime income of $824,940.
It is worth noting that the ability to file a restricted application for spousal benefits makes the strategy of maximizing delayed retirement credits more attractive and viable. The resulting increase in lifetime income can be especially impactful for those with few retirement assets or additional sources of income.
Scenario 2: Married couple ages 66/64 with similar benefits and a normal or long life expectancy.
- For those born after January 1, 1954, maximizing delayed retirement credits will take on new significance, as a restricted filing is not available.
- A restricted filing for spousal benefits, in most cases, will still yield the highest lifetime income when spouses have a similar PIA, are close in age, and expect to live to normal life expectancy or beyond.
- The relative importance of Social Security surviving spouse benefits will depend on the gap in Social Security retirement benefits, and whether and for how long they are collected.
In a case where both spouses have worked and have similar earnings a more nuanced set of options emerges. To illustrate, let’s revisit our married couple but assume instead that their primary insurance amounts (PIA) are similar at $2,000 per month and $1,950 per month, respectively. Assume again that the higher-earning spouse lives to age 83 and their spouse to age 85, and that their benefits are subject to an average cost of living adjustment of 2.5% per year.
The choices in this scenario are more plentiful and nuanced than in our previous example where a large benefit gap existed. To maximize lifetime income, based on the inputs, the higher-earning spouse should defer their Social Security retirement benefits until attaining age 68. The lower-earning spouse will collect Social Security spousal benefits based on the higher-earning spouse’s earnings record beginning at age 66. In turn, they will defer their own Social Security retirement benefits until age 70. In this example, both spouses make use of delayed retirement credits, with the younger and lower-earning spouse maximizing both their delayed retirement credits and the available spousal benefits. The result is lifetime income totaling $1,187,310.
If, instead, both spouses were to forego Social Security spousal benefits in favor of maximizing their respective Social Security delayed retirement credits, each would begin collecting benefits at age 70, with a resulting lifetime income of $1,141,386.
What if the higher-earning spouse has a short life expectancy and the lower-earning spouse a long life expectancy?
Reducing the life expectancy of the higher-earning spouse to age 75 and increasing the life expectancy of the lower-earning spouse to age 90 suggests that maximizing the Social Security surviving spouse benefit should be a key planning consideration. To that end, the lower-earning spouse will file an early application for their Social Security retirement benefits, allowing the higher-earning spouse to file a restricted application for spousal benefits. The higher earning spouse will earn delayed retirement credits, thus maximizing their Social Security retirement benefit and the Social Security surviving spouse benefit. The resulting lifetime income from this strategy is $1,232,730.
Scenario 3: Qualifying divorced spouses ages 66/64 with a wide gap in benefits and normal or long life expectancy.
- Divorced spouse benefits cease if you remarry. This may be particularly impactful in cases where there is a large difference in benefit amounts.
- To file for divorced spouse benefits your ex-spouse must have attained 62 years of age, but need not have filed for their own retirement benefits.
- Divorced spouses that do not qualify for Social Security retirement benefits under their own earnings record are limited to 50% of their ex-spouse’s PIA, while those that have earned their own retirement benefits (and were born on or before January 1, 1954) may file a restricted application for divorced spouse benefits while deferring their retirement benefits.
Divorced spouses that were married for at least ten years, divorced for at least two years, and currently unmarried may claim benefits based on the earnings record of their former spouse. And, unlike currently married spouses, qualifying individuals may file a restricted application for divorced spouse benefits even if their former spouse has yet to file for their Social Security retirement benefits.
To illustrate, assume that the couple illustrated originally in Scenario 1 is instead a qualifying divorced couple. The higher-earning spouse has a PIA of $2,000 per month, while their ex-spouse has a PIA of $800 per month. Neither has remarried.
The higher-earning spouse can maximize lifetime income by filing a restricted application for divorced spouse benefits upon attaining full retirement age. The lower-earning spouse must be age 62 or older, but need not have filed an application for their Social Security retirement benefits. The higher- earning spouse will collect Social Security spousal benefits while deferring their Social Security retirement benefits until attaining age 70, at which point they will file an application for their retirement benefits. The result is lifetime retirement income of $532,152. The availability of divorced spouse benefits adds more than $20,000 of additional lifetime income versus simply deferring Social Security retirement benefits to capture the maximum delayed retirement credits.
The lower-earning spouse will undertake a similar strategy of filing a restricted application for divorced spouse benefits upon attaining full retirement age. After collecting Social Security divorced spouse benefits for four years, they will switch to their Social Security retirement benefits at age 70. The net result in this case is additional lifetime income of $53,010 versus deferring their Social Security retirement benefits to capture the maximum delayed retirement credits.
Scenario 4: Surviving spouse or surviving divorced spouse age 64 with a PIA of $800 per month and a Social Security survivor of $2,000 per month.
In this final example, assume that the higher-earning spouse outlined in the first scenario dies at age 66 leaving behind a 64-year old spouse, or qualifying divorced spouse, with a normal life expectancy.
Social Security surviving spouse benefits (also referred to as widow or widower benefits) are governed by a unique set of rules, and afford recipients with additional latitude not available with other benefit types. There are a few important differences to remember:
- Benefits are based on the PIA of the deceased spouse and include any delayed retirement credits. Those credits are earned by the decedent until the earlier of the attainment of age 70, or up to but not including the month of death.
- Benefits may be claimed as early as age 60 (with reductions, and earlier still if disabled).
- Surviving spouse/divorced spouse benefits are claimed separately from Social Security retirement benefits (though still subject to a family maximum benefit).
- Social Security deemed filing rules do not apply to Social Security surviving spouse benefits.
As a result, surviving spouses are eligible to file a restricted application for Social Security surviving spouse benefits while deferring their own Social Security retirement benefits. Conversely, recipients may file a claim for their retirement benefits while delaying the collection of Social Security surviving spouse benefits until they have attained their full retirement age.
In this case, lifetime income is maximized if the surviving spouse files an application for their Social Security retirement benefits at age 64 and switches to their Social Security surviving spouse or surviving divorced spouse benefit upon attaining their full retirement age. The result is an additional $17,058 of lifetime income. Although a reduction for early filing and income-based reductions will apply, the surviving spouse can collect two years of retirement benefits before switching to the higher survivor benefit. What’s more, the surviving spouse benefit is not subject to a reduction even though retirement benefits were collected early. The logical extension of this set of facts is that the surviving spouse should collect their retirement benefits as early as possible, since they’ll eventually switch to a higher survivor benefit. This strategy results in total lifetime income of $608,244.
A word on taxes
Social Security benefits are subject to federal income tax, and may be subject to state income tax, depending on where you reside. Taxation of benefits is based on modified adjusted gross income, with up to 85% of benefits subject to federal tax.
Given that the income thresholds are fixed in nominal dollars (i.e., not inflation adjusted), and absent changes to existing legislation, the overall percentage of Social Security benefits subject to tax are expected to rise over time. In the aggregate, however, the percentage of Social Security benefits that are actually taxed remains low at approximately 10% of all benefits. This figure is expected to increase to approximately 12.2% by 2030 and approximately 15% by 2050. These finding suggest that many recipients have little or no additional income, and accordingly their benefits are subject to little or no tax. It further suggests that claiming strategies designed to maximize lifetime income will be highly effective in enhancing net income (and alleviating poverty), since such a modest percentage of aggregate benefits are subject to tax.
Don’t ignore the risk of longevity
Finally, while it may be tempting to file for benefits early, as more than 4 in 10 Americans over age 50 expect to do, underestimating how long you will live can prove costly. This is especially true for those with few additional assets or retirement income sources. In fact, deferring Social Security retirement benefits may be the single most effective way of boosting lifetime retirement income for those that find themselves short on retirement savings.
Social Security is uniquely effective in providing inflation-adjusted guaranteed income to millions of Americans, and for some means the difference between living in dignity and living in poverty. Live long and prosper, but ignore the risk of longevity at your peril.
John Male, CFP®, RICP®
The Gassman Financial Group
The Retirement Maven™
9 East 40th Street New York, NY 10016