Retirement planning entails finding ways to cover expenses when we ultimately cease or reduce our working income. The goal is to ensure that we don’t outlive our assets, regardless of our longevity.
To the surprise of many, one of the most valuable (yet under rated) tools to fund retirement is Social Security. Clients often ask about ways to bolster their retirement income; such as, maximizing their investments, reverse mortgages and annuities. They seldom consider how to maximize their Social Security benefits.
We pay for Social Security and Medicare through payroll taxes with the employer paying half of this expense and the employee, often grudgingly, paying the other half. In particular, I detect a sense of being “over taxed” by those who are self-employed and must therefore bear the full brunt of the Social Security tax. Some make it a goal to reduce their profit or earnings so that they can lower this tax, sometimes entirely avoiding paying any social security tax. And yet the very best inflation protected guaranteed income during retirement is Social Security. If you don’t pay the tax you don’t collect the retirement benefit.
I will outline a few interesting facts to help you understand aspects of Social Security that we consider when creating retirement projections.
Although you must have 10 years of Social Security taxed earnings to qualify for benefits the Social Security Administration actually uses the highest 35 years of earnings (any missing years are zeroed) to calculate your retirement benefit. To earn the maximum retirement benefit you would need to pay social security tax at the highest level allowed each year for 35 years. Each year the maximum social security taxable earnings changes. In 2014 it is $117K.
The earliest age you can begin to collect Social Security is 62 while the Full Retirement Age (FRA) is now between 66 and 67, dependent on your birth year. Unless in poor health, it is seldom advantageous to collect Social Security benefits before reaching FRA. Collecting Social Security prior to FRA will close the door on some options that can help maximize your Social Security income and should only be considered in unusual situations.
Many file for benefit at their FRA whereas others delay filing until sometime after FRA. Waiting until as late as age 70 to collect these benefits can significantly increase the Social Security payout for a lifetime.
One feature of Social Security that often surprises clients is the option to collect spousal benefits. Spousal benefits uses only your spouse’s work history to provide you with half of your spouse’s social security benefits. One way to use this option is (once you reach your FRA) to choose to delay filing for Social Security based on your own work history and instead claim half of your spouse’s benefits. Why would you do that? By collecting a reduced spousal benefit you can allow the benefit based on your own work history to continue to grow until up to age 70.
What are some considerations associated with receiving spousal benefits? The marriage must have lasted at least 10 years. You can claim based on your ex-spouse’s Social Security benefits so long as you’ve not remarried (or if you remarry after age 60). You can only claim a spousal benefit when you’ve both reached FRA. This feature works maximally for same age spouses since they can both claim spousal benefits on each other, therefore collecting Social Security while still allowing their own Social Security to grow until age 70.
One unpleasant feature of Social Security is called the Windfall Elimination Provision which can surprise workers who have worked for two employers where one was not subject to Social Security withholdings. The social security benefits are reduced even though the second earnings were subject to Social Security withholdings. We see the Windfall Elimination most often with teachers who also worked in other non-teaching positions.
So are Social Security benefits taxed? Yes. 85% of your Social Security earnings will be part of your retired taxable income. This can drop to 50% if the in-retirement AGI is low enough.
Your Social Security tax payment entitles you to guaranteed retirement income, an essential part of the retirement plan for most Americans. The important role Social Security plays in your retirement planning cannot be over stated. A sole conversation with Social Security Administration should not be enough. Considering that the Social Security handbook has over 2,700 rules in a thick manual called POMS (Program Operating Manual System) it should come as no surprise to you that the Social Security Administration can’t always provide the best information in relation to your own situation.
Take the time to determine what will be the best way to deploy your Social Security scenario since this retirement income will be both inflation protected and last you through your entire retired life.
Edi Alvarez, CFP®
BS, BEd, MS