Welcome to the second part of our two-part series on how to maximize your Social Security benefits! In our previous post we covered the fundamentals of Social Security with the goal of providing the basic knowledge that is necessary to understand how to get the most out of the Social Security system. If you have not read part-one yet, we recommend you take a few minutes to read it before proceeding with the rest of part-two.
In part-two, we will take the facts previously discussed and consider strategies that each person can utilize to maximize their lifetime benefits. Before we begin, there are two important points to consider:
- First, each individual’s situation is different. This article covers general rules for common scenarios, but is not intended to be specific advice for any individual person.
- Second, Social Security has countless rules to account for almost every imaginable scenario. While there are general approaches that maximize benefits for most individuals, we utilize software for our clients to analyze each possible claiming strategy to ensure they implement the best approach customized for their unique situation.
With that general context out of the way, let’s discuss strategies to maximize Social Security benefits.
Ensuring You Qualify for Social Security Benefits:
At the most basic level, each individual needs to ensure they qualify for the benefits they intend to receive.
In part-one we explained that qualifying for Social Security benefits is based on each individual’s work history. Individuals are required obtain 40 credits which typically equate to 10 years of work before they qualify for benefits under their own work record.
Individuals who plan to claim benefits under their own record need to monitor the number of credits that they’ve earned to ensure they’ve met the 40-credit limit. Each individual can check the number of credits they’ve earned by creating an account and logging in on the Social Security Administration’s website at SSA.gov.
Although having 40 credits is necessary for an individual to qualify for benefits under their own work record, many individuals may never claim benefits using their own record. For example, married individuals can claim a spousal benefit based on the work record of their spouse and are entitled to survivor benefits once their spouse has passed away. Spousal and survivor benefits do not have the same 40 credit requirement; so a stay-at-home spouse can qualify for spousal and survivor benefits even if they have no work record of their own.
Maximizing Your Average Earnings:
As discussed in part-one, Social Security benefits are calculated based on average indexed monthly earnings (AIME). An individual’s AIME is the monthly average earnings over their 35 highest earning years after adjusting each year for inflation.
For individuals planning to claim benefits based on their own record, the initial consideration is whether they have at least 35 years of working history. When the Social Security Administration calculates the average monthly earnings for an individual who retires prior to reaching 35 years of working history, they include years with zero earnings in the calculation. Including years with zero earnings will reduce the average monthly earnings.
The same logic applies for individuals who have already reached 35 years of work history but have low earnings in certain years. Replaced low earning years by working an additional year or two prior to retiring will increase average monthly earnings.
How Much Does Increasing My Average Earnings Matter?
In part-one we discussed that average earnings translate into Social Security benefits based on a formula. The formula includes three tiers and the portion of the individual’s average indexed monthly earnings (AIME) falling within each tier is multiplied by a crediting percentage. The tiers for 2022 are:
- Less than $1,024 credited at 90%
- Between $1,024 and $6,172 credited at 32%
- Over $6,172 credited at 15%
Since the crediting rate decreases as income increases, an individual with average monthly earnings in excess of $6,172 will benefit much less from increasing their average monthly earnings than someone whose average monthly earnings are less than $1,024.
The following graph shows how an individual’s normal retirement age benefit will increase as a result of a $1,000 increase in their average earnings. These examples assume an initial average monthly earnings amount of $1,000 in the first scenario, $5,000 in the second scenario, and $8,000 in the third scenario.
As the graph shows, an individual who has average monthly earnings of $8,000 receives a much smaller increase in their Social Security benefit from a $1,000 increase in average monthly earnings than an individual who has average monthly earnings of $1,000.
Accordingly, working additional years to increase average monthly earnings will have a larger impact for individuals who have not had significant earnings over their career and less of an impact for high income earners.
Key Takeaway:
While working additional years may increase your benefit, the increase may not be substantial for high income earners.
Should I Claim Social Security Benefits Early or Delay Until Later?
Deciding when to claim Social Security benefits is an important decision for nearly every retiree. As discussed in part-one, individuals who claim their benefit early receive a reduced benefit and those who delay receive an increased benefit.
The following graph shows how the Social Security benefit of an individual with a normal retirement age of 67 and a benefit at normal retirement age of $1,000 changes based on the age they start receiving benefits
As the table shows, claiming benefits at age 62 reduces the total benefit to 70% of the normal retirement age benefit, a 30% reduction. Claiming benefits at age 70 increases the total benefit to 124% of the normal retirement age benefit, a 24% increase.
The current adjustments for claiming Social Security before or after normal retirement age were implemented as part of the 1983 Social Security amendments. The adjustments were calculated so that the value of an individual’s lifetime benefits would be the same regardless of whether they claimed their benefit early or late. That calculation was performed by actuaries using life expectancies, interest rates, and other factors at that time.
The interesting point to note is that the adjustments have not changed despite significant changes in the underlying data. This effect has been researched by the Center for Retirement Research at Boston College, and they have published findings in both 2019 and 2021.
To illustrate how things have changed consider the fact that interest rates have declined significantly since 1983. At the beginning of 1983, the 10-year US Treasury yield was 10%. Currently it is 2%. As another example, average life expectancy of a 65-year-old individual in 1983 was 17 years. That life expectancy has increased to 20.4 years (Munnell & Chen, 2019, p3).
Key Takeaway:
The adjustment amounts for claiming before or after normal retirement age are based on information that is outdated and decades old.
Based on the research conducted, the appropriate adjustments would be smaller meaning those who claim early currently receive too large of a reduction in benefits and those who claim later receive too large of an increase.
For someone with a normal retirement age of 67, the benefit for claiming at age 62 should be 77.5% of the normal retirement age benefit instead of 70% as it currently is. On the flip side, the benefit for delaying until age 70 should be 119.9% of the normal retirement age benefit instead of the current amount of 124% (Biggs et al., 2021, p3).
Key Takeaway:
The adjustment amounts excessively penalize individuals claiming early and are overly generous to those who delay.
While these numbers would suggest that the average person should delay taking their Social Security benefit until age 70, the most common claiming age is still age 62.
If the adjustments are outdated, why doesn’t Social Security update the calculations? It’s impossible to know for sure; however the research shows that the outdated adjustments save the Social Security Administration billions of dollars each year.
The study by the Center for Retirement Research reviewed the data for new Social Security beneficiaries in 2018 and calculated that Social Security will save $1.9 billion dollars each year from the 2018 class of new recipients due to the outdated adjustments (Biggs et al., 2021, p8).
This occurs because most people take their benefit early and receive too large of a reduction in benefits. These reductions more than offset the overly generous benefits paid out to the smaller proportion of individuals that wait until age 70.
Based on this research, the initial presumption for the average individual should be that they will be better off over the course of their lifetime by delaying their Social Security benefit until age 70.
This initial presumption can be complicated by the availability of spousal benefits, survivor benefits, and each individual’s specific circumstances; so it does not hold true in every situation. However, it is the appropriate starting point for understanding the value of delaying benefits in many situations.
Key Takeaway:
As a general rule, delaying Social Security to obtain the maximum delayed retirement credits increases lifetime benefits.
Side Note: An important point to note is that delaying Social Security until 70 does not necessarily mean that retirement needs to be delayed as well. Many individuals retire well before 70, and bridge the gap using savings and retirement accounts. Then once they claim their increased Social Security benefits, the higher benefit amount often covers most of their living expenses reducing the need to draw on other retirement assets.
Social Security Strategies for Married Couples:
Claiming Individual Benefits: The most common scenario is a married couple where one spouse has a better work record than the other spouse. In these cases, it typically makes sense for the spouse with the best work record to delay taking their Social Security benefit until age 70. The reason is that their benefit will receive all the delayed retirement credits, and those benefit increases will last for as long as either spouse is alive.
To clarify, if the spouse with the lesser work record passes away first, the surviving spouse will simply continue claiming their own benefit which already received the delayed retirement credits. If the spouse with the better work record passes away first, the surviving spouse will switch from their own lesser benefit to a survivor benefit based on the deceased spouse’s record. That survivor benefit will include any delayed retirement credits earned by the deceased spouse prior to death.
Regardless of which spouse passes away first, the benefit of the delayed retirement credits earned by the spouse with the better work record will last until both spouses have passed away.
Key Takeaway:
Delayed retirement credits earned by a deceased spouse carry over to survivor benefits.
For the spouse with the lesser work record, delaying their own benefit until age 70 will also result in delayed retirement credits; however in their case, the increased benefit will only last until one of the spouses passes away. The reason is that if the spouse with the lesser work record passes away first, that benefit will vanish because the surviving spouse will continue drawing their own larger benefit.
Alternatively if the spouse with the better work record passes away first, the surviving spouse will switch to a survivor benefit and will give up their own benefit. Accordingly, any delayed retirement credits earned by a spouse with the lesser work record are likely to end more quickly. As a result, the decision to delay is not as clear for the spouse with the lesser work record.
Age gaps between spouses can further impact the decision-making process. If the spouse with the lesser work record is also multiple years younger, any benefit from delaying until age 70 likely will end even sooner as their older spouse will be much older than 70 at the time the spouse with the lesser work record begins claiming their benefit. This fact may lead the spouse with the lesser work record to choose to claim their Social Security benefit much earlier.
Ultimately deciding when to begin benefits for a spouse with a lesser work record will depend on the facts and circumstances of each case including the health of both spouses, current income needs, and general life expectancy of both individuals.
Key Takeaway:
Spouses with lesser work records may benefit by claiming their individual benefit prior to age 70.
Claiming Spousal Benefits: Spouses with minimal work records of their own, can qualify for spousal benefits based on the work record of their spouse. For purposes of this section, the spouse claiming benefits on their own record will be called the “primary spouse” and the spouse claiming spousal benefits will be called the “secondary spouse.”
It is also important to distinguish between the terms “spousal benefit” and “survivor benefit.” Spousal benefits apply when both spouses are living, and survivor benefits apply once a spouse has passed away. The rules applying to each benefit are different; so understanding which benefit is being discussed is key to understanding the following discussion.
Before claiming spousal benefits, the primary spouse must already be collecting benefits. The maximum spousal benefit that can be received is 50% of the primary spouse’s normal retirement age benefit. Any delayed retirement credits that the primary spouse receives for delaying their benefit past their normal retirement age will not increase spousal benefits.
Spousal benefits that are claimed prior to reaching normal retirement age can be reduced by 35%. The reductions are approximately 7% for each year prior to normal retirement age. There are no delayed retirement credits for delaying a spousal benefit past normal retirement age.
The range of spousal benefits for a secondary spouse with a normal retirement age of 67 is illustrated in the following chart. The example assumes the primary spouse has a normal retirement age benefit of $1,000 and has received $240 of delayed retirement credits.
For individuals who have a work record of their own, filing an application for spousal benefits will be treated as filing for their own benefit as well. Social Security will pay whichever benefit is larger, but both benefits will be permanently reduced if the filing occurs prior to normal retirement age.
Typically it makes the most sense to wait until at least normal retirement age to claim spousal benefits unless there is the expectation that the primary spouse has a short life expectancy. In that case, filing early to claim a reduced spousal benefit may make sense with the expectation that those reductions will be short lived as a result of switching to a survivor benefit in the near future (survivor benefits are not affected by claiming individual or spousal benefits early).
Key Takeaway:
Spousal benefits are available to married individuals even if they have no work record of their own.
!!! Loop Hole !!! There is a loop hole in the Social Security rules. Typically the rules do not allow an individual to file for spousal benefits while also allowing their own individual benefit to grow. However, individuals who meet the following three criteria can file a restricted application for spousal benefits only and allow their own benefit to grow while collecting spousal benefits.
- Are born on or before January 1, 1954
- Have reached normal retirement age, and
- Have a spouse already claiming retirement benefits
This loop hole only impacts a small group of people because everyone born on or before January 1, 1954 has already reached at least 68 years of age. Accordingly, this strategy is a moot point for many individuals because they are either too young or they have already received the maximum delayed retirement credits by reaching age 70.
However, for those who meet the criteria, this can be a great strategy to get the best of both worlds by receiving spousal benefits now while still letting their own benefit grow.
Claiming Survivor Benefits: Surviving spouses are allowed to receive a survivor benefit based on the Social Security record of their deceased spouse. The survivor benefit is typically equal to the benefit the deceased spouse was receiving.
For example if the deceased spouse delayed taking their benefit until age 70, the delayed retirement credits they received will transfer to the survivor benefit. Alternatively , if the deceased spouse took their benefit early, the reductions will also apply to the survivor benefit.
There is a provision that the survivor benefit cannot be reduced below 82.5% of the deceased spouse’s normal retirement age benefit. Accordingly a surviving spouse whose deceased spouse claimed their benefit early will not have their survivor benefit reduced below 82.5% of what the deceased spouse’s normal retirement benefit would have been.
Key Takeaway:
Increases or decreases from claiming Social Security before or after normal retirement age transfer to survivor benefits (subject to a minimum threshold).
The survivor benefit that a surviving spouse is entitled to can be further impacted by the age at which the surviving spouse claims the survivor benefit. Survivor benefits typically can be claimed as early as age 60 or as late as normal retirement age.
If the benefit is claimed prior to normal retirement age, it is subject to similar reductions for early claiming. Survivor benefits reach their maximum amount at the normal retirement age of the survivor and cannot be further increased even if the survivor delays longer.
Because adjustments for claiming benefits early or late carryover to survivor benefits, it is extremely important to consider how a primary spouse’s claiming decision may impact a surviving spouse in the future.
An important planning point is that survivor benefits (unlike spousal benefits) are allowed to grow independently from an individual’s personal Social Security benefit. In other words, an individual who qualifies for a survivor benefit can choose to take either their own benefit or the survivor benefit and allow the other to grow. This provides for current income while still receiving the additional benefit of delaying the other payment so that it can grow.
Typically, the best approach for a surviving spouse is to initially take whichever benefit is smaller (individual or survivor), and delay the larger benefit until later. The larger benefit will receive larger increases from delaying, and then once the larger benefit has received all the increases available, the survivor can switch to that benefit for the rest of life.
The following graph shows the impact of this strategy for an individual who has a normal retirement age benefit of $1,000 based on their own work record and a normal retirement age survivor benefit of $2,000 based on the work record of the primary spouse.
Taking their personal benefit at age 62 will result in a monthly benefit of $700 which is $892 less than the $1,592 survivor benefit they would qualify to take at the same time. However by taking their own benefit, they can allow their survivor benefit to grow to its full $2,000 value (a $408/month increase) as of normal retirement age. Then they can switch to the survivor benefit at that time and receive the larger benefit for life.
Key Takeaway:
Individual benefits and survivor benefits grow independently of each other; so coordinating your claiming strategy is important.
Delaying Social Security Improves Tax Planning Opportunities:
For individuals who have substantial pre-tax retirement accounts or unrealized capital gains, early retirement provides significant tax planning opportunities. Individuals who retire early typically find that they have very little taxable income in the initial years after retirement.
This provides a great opportunity to convert pre-tax accounts (employer retirement accounts or IRAs) into Roth balances or harvest capital gains. Roth conversions and capital gains count as taxable income, but with very little other income, there is typically an opportunity to realize this income at very low tax rates.
The timing of claiming Social Security benefits impacts the effectiveness of these tax planning strategies. Those who take Social Security prior to age 70 add income to the mix that can fill up the lowest tax brackets leaving less room for Roth conversions or realized capital gains. Adding Social Security to the mix can also substantially increase marginal tax rates due to the Social Security Bump Zone effect that was discussed in part-one.
For example, the following chart demonstrates how taxable income changes for a family where both spouses retire at age 62 but delay Social Security and pre-tax retirement distributions until age 70. In the early years of retirement, taxable income is very low (even negative in some cases) providing an opportunity to accelerate income into the low tax brackets.
As the graph shows, the early years of retirement before Social Security and retirement account distributions begin provide opportunities for accelerating income into low tax brackets. Taking Social Security early can reduce this opportunity.
Key Takeaway:
Taking Social Security early can complicate tax planning strategies.
Longevity Insurance and Inflation Protection:
Most individuals receive a portion of their retirement income from sources other than Social Security such as withdrawals from retirement accounts. While withdrawals from retirement accounts are important, they are not guaranteed to last for your entire lifetime or rise with inflation.
Alternatively, Social Security benefits last until death and are inflation adjusted annually. A good example of this is the 2022 inflation adjustment which was 5.9%.
While building a nest egg and saving for retirement is important, the fact that Social Security benefits provide benefits for life that are adjusted for inflation makes Social Security itself a very valuable asset that provides a form of insurance against outliving your money or losing purchasing power over time.
To the extent an individual expects there may be a risk of depleting their retirement portfolio, it becomes important to delay Social Security benefits to increase the portion of their retirement income that is guaranteed for life.
Key Takeaway:
Social Security provides protection against outliving your income and inflation.
What If I’ve Already Claimed My Benefits?
For individuals who have already claimed their Social Security benefits and would like to change their decision, there are two options to consider.
First anyone can withdraw their Social Security application within the first twelve months of filing. They will be required to pay back the benefits they have received, but then they will be treated as if they never filed and their future benefit amount will increase with each year they wait before reclaiming benefits.
Individuals who need to repay benefits often question how to financially accomplish paying back the funds they received. In many cases, using taxable investment accounts or even retirement accounts to repay the benefits may make sense.
The second option is for anyone who has already reached normal retirement age. After normal retirement age and before age 70, an individual can request to suspend their Social Security benefit.
When benefits are suspended, delayed retirement credits will accumulate until the benefit is reinstated or the individual reaches age 70 at which point the benefit will automatically resume.
An important point to note is that when an individual suspends their benefit, any spousal benefits being paid will also stop.
Conclusion:
Social Security is an important system that provides income that many retirees rely upon in retirement. Although Social Security is a very complex system, most individuals make their claiming decisions giving little thought to the long-term implications.
Considering the importance of Social Security to many retired families and surviving spouses, taking the time to understand how the system works and which approaches are most likely to lead to maximizing lifetime benefits is well worth the effort.
If you are interested in having one of our Family CFOs review your Social Security benefits and consider whether there are ways for you to maximize your Social Security benefits, we would love to connect to see if what we do is right for you.
References:
- Alicia H. Munnell and Anqi Chen (2019). Are Social Security’s Actuarial Adjustments Still Correct? (Number 19-18). Center for Retirement Research at Boston College. https://crr.bc.edu/wp-content/uploads/2019/11/IB_19-18.pdf
- Andrew G. Biggs, Anqi Chen, and Alicia H. Munnell (2021). The Consequences of Current Benefit Adjustments for Early and Delayed Claiming (CRR WP 2021-3). Center for Retirement Research at Boston College. https://crr.bc.edu/wp-content/uploads/2021/01/wp_2021-3.1.pdf
