With the exception of many federal, state and local government employees as well as railroad workers, most workers are covered under social security. Now that Congress has averted falling over the fiscal cliff while not addressing the larger issue of cutbacks in entitlements, workers who are considering applying for social security retirement benefits can focus on making calculated decisions about this extremely important facet of retirement income planning.
For individuals born between 1943-1954, the required age to collect full benefits or so-called Full Retirement Age (FRA) is age 66. The FRA gradually increases for workers born between 1955-1960 until it reaches age 67 where it remains fixed for workers born in 1960 and beyond. However, one may opt to take an early retirement benefit as early as age 62. If this election is taken, the benefits are reduced by 5/9 of 1% for each of the first 36 months plus 5/12 of 1% for each month in excess of 36. For those individuals considering this early retirement option, it is crucial to understand that reduction in benefits are irrevocable and may exist for your lifetime.
The other important consideration when deciding whether to begin collecting social security at age 62 is the potential loss of benefits resulting from other sources of earned income. In 2013, an early retiree may have annual wages or self-employment income of $15,120 without losing any social security benefits. For every $2.00 he or she earns in excess of this limit, there is a $1.00 reduction in benefits. If FRA occurs in 2013, the retiree may earn $40,080 for the months prior to attaining age 66 without reducing benefits. Income that exceeds this limit will reduce benefits by $1.00 for every $3.00 of earnings.
This loss of benefits makes the process to decide whether to elect early retirement rather easy. Not only does an individual realize lower benefits prior to attaining FRA, but he/she may also be subject to a further reduction in benefits if the two income thresholds are surpassed. In my opinion, the only individuals who should opt for the early retirement election are those who have both a desperate need for income and little or no income producing assets as well as those individuals who have a medical condition or history that is likely to significantly reduce their life expectancy.
For those individuals who do not need social security at FRA, they may delay the commencement of benefits until age 70. The advantage of this delay is an 8% annual increase in the monthly benefit. It seems apparent that for those who plan to work to age 70 or beyond and anticipate a reasonable life expectancy, deferral of benefits is clearly the preferred route. Where else can you receive a guaranteed 8% annual raise in income over a 4 year period?
Planning for spouses becomes more complicated and problematic. Even if an individual does not qualify for social security benefits based on earned income, every spouse is eligible for a spousal benefit. In the case of a married person who has contributed to social security, that person must take their own social security benefit if they file for benefits before FRA. If they delay filing until FRA, they have the option of taking his or her own benefit or one-half of the spouse’s benefit. In order to qualify for a spousal benefit, the other spouse must file for benefits. However, the other spouse may voluntarily suspend their benefits if they are FRA or older to a later date in order to increase their benefit by the aforementioned 8% per year. If a worker dies before attaining FRA, the surviving spouse may receive a survivor’s benefit as soon as age 60. The Primary Insurance Amount (PIA) would be reduced to 71.5% at age 60 and is prorated upward for the months between age 60 and the FRA when benefits actually begin.
Perhaps, this voluntary suspension to delay receiving social security retirement benefits is the most important and flexible planning tool available. Not only does it allow an individual to delay receiving current benefits and increasing them by 8% per year, the spouse may file for spouse’s benefit even though the eligible individual is not collecting a retirement benefit. This 8% increase can also be passed on to the spouse in the event of the individual’s death that results in the payment of survivor’s benefits. Finally, if the person requesting a voluntary suspension at age 66 changes their mind and subsequently decides to request their benefits, they can ask social security for a one time retroactive payment for benefits reaching back to age 66, but they would forfeit the 8% per year increase.
No matter when benefits begin, a portion of social security payments may be taxable. The determination of taxation depends on a calculation of provisional income that includes earned income, capital gains, dividends and other investment income plus any tax exempt interest and 50% of your social security benefits. For single individuals with a provisional income between $25-34,000, 50% of social security benefits in excess of the $25,000 threshold are subject to tax. If their income exceeds $34,000, up to an additional 35% or 85% of benefits are subject to taxation above this second threshold. The income limitations for married couples filing a joint return are $32-44,000 at the 50% level and greater than $44,000 to move up to 85%. Three calculations are performed using this information and the taxpayer applies the smallest of the three figures to add to their adjusted gross income for tax purposes. For those recipients who are currently paying taxes on social security benefits or whose projected income may place them over the income limits, strategies should be analyzed and pursued that may allow you to avoid or limit these taxes. Chief among these strategies is one that derives income from excludable sources such as Roth IRA distributions and partially tax free distributions from annuity payments.
The current crop of near retirees, the baby boomers, tend to work and live longer than their parents. While the seemingly obvious conclusion is that the vast majority of workers should strive to delay the onset of social security retirement benefits until age 70 in order to increase their benefits by 8% annually, every situation is unique and the ultimate decision lies with a careful analysis of the factors that apply specifically to you and your family.
Clifford L. Caplan, CFP®, AIF®