No forfeiture of benefits and cost-of-living adjustments (COLAs)First and foremost, by waiting until full retirement age to claim, you could avoid forfeiting a significant percentage of full retirement age benefits and the cost-of-living adjustments that you would receive on those lost benefits. These two factors can have a dramatic effect on the cumulative benefits you’ll receive. Let’s look at an example to get a better idea of how big of a difference delaying benefits can mean to you over the long run, shall we? Let’s make believe that your full retirement age (FRA) was 66, and your Primary Insurance Amounts (PIA) at FRA was $2,000 per month. If you elected to claim reduced benefits at age 62, you’d forfeit 25 percent of your PIA, which means $2,000 would become a $1,500 per month benefit. We’ll also assume a cost-of-living Adjustment (COLA) of two percent. However, the two percent COLA is now applied only to $1,500, not $2,000. Therefore, you would lose the cost-of-living adjustment that would have been applied to High-Income Earners’ Guide To Optimizing Social Security Benefits the forfeited five hundred dollars of benefit. If you live until age 90 (collecting benefits over 28 years), your cumulative lifetime benefits would be $666,921. That’s a significant amount, but let’s look at what they could be if you instead waited until age 66, your full retirement age, to take Social Security benefits. Because you waited, you’ll receive 100 percent of your benefits and the COLA on the entire amount. If you live until age 90 (collecting benefits for only 24 years), your lifetime cumulative benefits would be $730,124. That’s $63,203 more! Part of what makes a difference in your cumulative benefits is the cost-of-living adjustment––even though it may not seem like much. In fact, this effect of waiting often gets overlooked. But it’s important because it’s the only way to help you gain some of your purchasing power back. The COLA is currently based on the percent increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The SSA looks at the CPI-W in the third quarter of the previous year and compares that to the third quarter of the current year. Any positive adjustment in Social Security benefits is calculated and announced in October and the cost-of-living adjustments becomes effective starting in January the following year. If there is no increase in the CPI-W, the COLA for the next year would be zero percent. If the CPI-W decreases from one year, the next COLA is still zero percent. Zero percent is the floor, and your benefit payments would never decrease because of deflation. Although your benefits will not decrease, no positive COLA would be applied until the CPI-W exceeds the previous high point.13,14 Here’s a lookback at cost-of-living adjustments over the years. The years with a zero percent COLA are because the CPI-W had decreased from the previous year. For example, in 2008 the COLA was 5.8 percent because of the CPI-W’s increase year over year from the third quarter of 2006 to 2007. However, in 2009 and 2010 the COLA was zero percent because the CPI-W had decreased because of the Great Recession of 2008 and 2009. The CPI-W did not increase beyond the 2007 level until the third quarter of 2010, resulting in a positive COLA for 2011.
Source: Social Security Administration. Cost-of-Living Adjustments. https://www.ssa.gov/OACT/COLA/colaseries.html. (Visit URL to view larger image.)
You may wonder if there will come a time when COLAs will not be made, and your Social Security payments no longer be inflation adjusted. It’s possible, but not likely unless there was a major change in legislation. Currently, future cost-of-living adjustments for Social Security and Social Security Insurance (SSI) must be tied to the Consumer Price Index per legislation from 1972, which has been in effect since 1975. Under current law, the cost-of-living adjustment calculation occurs each year without any congressional action.
There have been numerous legislation proposals centered around changing the yardstick that is used to measure the cost-of-living adjustment from year to year––changing from the CPI-W to another consumer price index (yes, there are several variations). However, no legislation has been introduced yet that would completely get rid of the COLA. Although, if the Social Security trust fund was depleted, benefits may have to be reduced.
If you don’t have a cost-of-living adjustment to hedge against inflation, the money you have today won’t buy you nearly as much in the future as it does now. Think about rising cost of health care, for example, it would be much more difficult to manage those expenses without a COLA to help offset some of that increase.
Avoid the earnings limit
Many folks are still working into their 60s and wonder if they can claim Social Security benefits while they’re still working. Claiming Social Security before full retirement age will subject Social Security benefits to the earnings limit discussed earlier in the book.
If you are making a good income, there’s a chance you may receive no benefit check at all if you claim early — simply because you exceeded a base amount as defined by the IRS.
You may also end up paying taxes on a significant portion of your Social Security benefits at a higher effective tax rate due to your employment income. We’ll talk more about this when we get to the section on taxation of benefits.
Super-size survivor benefits
Another potential reason for claiming benefits under a delayed strategy is to increase the survivor benefit.
One spouse is often a lower wage earner, and the other spouse is a higher wage earner. When one of the spouses passes away, the surviving spouse will generally receive the higher of the two Social Security benefits and lose the lower one.
It can often make sense for the lower wage-earning spouse to claim benefits early and get cash flow coming into the household retirement income plan while the higher wage earner delays benefits to earn delayed retirement credits and increase the future survivor benefit.
Since 30 percent of women outlive their husbands by more than a decade, compared to 18 percent of men outliving their wives by more than 10 years, most survivor benefits are received by widows.15 Therefore, it can be somewhat of a women’s planning issue when making Social Security claiming decisions.
But it’s quite common to see a husband with a higher Social Security benefit. There may be many reasons for this, and while it’s not always the case, it is most common. Meanwhile, the wife may have been the lower wage earner for several reasons, and she may often be the younger spouse.
It can be a selfless decision for an older male spouse to delay claiming Social Security benefits as a higher wage earner even though there might be a natural desire for him to want to claim early and start receiving benefits on his record. Delaying so that the survivor benefit is optimized will likely profoundly impact his spouse after he’s gone.
Acting on impulse and claiming early under these conditions could be viewed as a selfish decision. It would permanently reduce Social Security benefits for the household, he’d lose out on any delayed retirement credits, and consequently the survivor benefit would be permanently reduced as well.
Helping spouses coordinate benefits is one way your financial professional can guide you regarding retirement income planning and Social Security claiming strategies. We’ll talk a bit more about retirement, spousal and survivor benefits shortly.
We’re living longer
Another reason you may choose to delay claiming social security is that we’re living longer, and our retirement income must last as long as we do. Life expectancies have increased substantially.
According to the Society of Actuaries, 1 in 3 men and 1 in 2 women in their mid-50s will live to be age 90. For couples age 65 today, there’s a 50 percent chance that one will live to age 92.15
Developing a strategy in which retirement resources are exhausted at a person’s life expectancy will fail 50 percent of the time. By definition, life expectancy is the midpoint at which half a peer group is alive, and half a peer group has passed. If a retirement income strategy isn’t sufficient to get beyond life expectancy, the odds of running out of money may be the same.
Delaying Social Security benefits can help you increase the odds of not running out of money and planning for their surviving spouse’s wellbeing.
It’s tax-advantaged income
By coordinating your retirement resources, including Social Security strategies, it may be possible to reduce taxable income during the waning years of retirement.
Sometimes it makes sense to delay Social Security benefits and use pre-tax (IRA or 401(k)) retirement assets to help fill the gap. For example, suppose someone wanted to retire at age 65. In that case, it might make sense for them to use some of their pre-tax money to maintain their lifestyle from age 65 to 70 while they allow their Social Security benefits to earn delayed retirement credits.
By the time they turn on social security, which is tax advantaged, government backed, and inflation adjusted, they may have spent down a good portion of their pre-tax dollars. In that case, their required minimum distributions after age 72 are likely to be lower than they would have been otherwise. Since distributions from pre-tax accounts have a profound impact on the taxation of Social Security benefits, this may be one way to help mitigate those taxes.
You may not be able to immunize benefits from taxes completely, especially considering most people’s retirement accounts are pre-tax accounts. But if a financial professional can consider someone’s tax bracket and keep their next taxable dollar distributed in a tax lower bracket, that person could potentially lower the taxes they pay on social security.
For that reason, a delayed claiming strategy to build a more considerable Social Security benefit can have a more significant positive tax impact than most people realize.
That’s why the decision about when and how to claim Social Security benefits to maximize household retirement resources is not one you will want to take lightly.
Once you make a decision regarding your Social Security claiming strategy – in most cases, that decision cannot be reversed. So, to help you in making the appropriate decision, next we’ll cover important claiming considerations to discuss with your financial professional.
As you can see so far, decisions regarding your Social Security benefits are very complex. If you feel confused, it’s not your fault, and you are not alone!
Consulting a financial professional that can evaluate all of your assets and determine your basic income needs as well as intelligently discuss Social Security claiming options, can help you determine how to cover retirement necessities. They can also help you position your assets to allow for luxury items you may want, free up other assets in a way that could either help mitigate taxation and offer a potential hedge against inflation so that you not only survive, but thrive, in retirement.