By David LaMartina, ThinkAdvisor
Social Security is complex, to say the least. Between filing ages, spousal benefits and complications caused by earned income and pensions, many seniors feel they’re in over their heads.
“It’s a very much a self-help system,” says Rob Arthur, First Vice President of the Federal Benefits Consulting Team at Wells Fargo Advisors. “There’s no official who will tell you there’s a better way to do things, and retirees are left to take it all on themselves.”
Given the system’s complexities, several Social Security misconceptions have become common – many of which lead retirees to make ill-advised filing decisions. For instance, why should a client delay collection if they don’t understand how much their benefits will increase, or if they believe the system will be insolvent within a decade? Likewise, why would an early collector go back to work if they believe they’ll permanently forfeit some of their benefits?
Myth: You get back what you put in
Early filers often say that because they’ve been paying into the system for decades, they want to finally “get back” what they’ve put in.
“Some people think, for some reason, there’s an account set aside for them,” says Ash Ahluwalia of Atlas Advisory Group. Benefits are actually based on beneficiaries’ best 35 inflation-adjusted years of work, and they’re paid for with current payroll taxes, bonds and bond interest.
“In nominal dollars, you’ll actually get most of your money back within a few years,” Ahluwalia adds.
Aside from filing too early, this fallacy leads some seniors to work longer than they need to. A few more years at a peak salary may boost the average a bit, but it won’t have nearly the impact of simply working long enough to eliminate any zeros. For someone who’s already earned enough to get the maximum primary insurance (PIA) amount of $2,687 per month, it won’t have any effect at all.
Myth: You’re only entitled to your own retirement benefits
Single-income couples should know: Stay-at-home spouses are entitled to benefits. Even a spouse with no earnings record can receive up to 50 percent of the breadwinner’s benefit, although penalties are a little steeper for collecting early. Now that File and Suspend has come to an end, however, the primary beneficiary must be collecting their own benefits before their spouse can piggyback.
If the breadwinner dies, survivor benefits entitle the widow or widower to 100 percent of the deceased’s benefit. Plus, when a spouse dies before collection age, their survivors are still entitled to full benefits at full retirement age and reduced benefits as early as 60.
The SSA will automatically assign spousal benefits, but the beneficiary has to actually collect in the first place – something not all clients know. Also, assuming the breadwinner is filing later than 62, their spouse can (and probably should) draw their own benefit in the meantime. “They may not be eligible for the spousal benefit because the spouse isn’t drawing yet, but they can be transitioned in the future,” says Arthur.
Myth: If you work, you’ll forfeit your benefits
For clients who work while collecting at the full retirement age (FRA) or later, no amount of earned income will impact their benefits. For early collectors, there is an earnings limit — $17,640 in 2019. One dollar is deducted for every $2 earned over that limit, and the total deduction is taken in a lump sum from the next year’s checks.
That benefit isn’t lost forever, however. Once the worker reaches FRA, monthly benefits will be increased to pay back the deducted amount; the total deduction is usually paid back within 15 years.
Early collectors who work, in fact, may realize a twofold benefit later on: They’ll receive the deductions later in life, when they need them more, and any income earned before FRA still contributes to their earnings record, potentially boosting their monthly checks. “If you do collect before your full retirement age, you’ll be better off at FRA for working,” says Barry S. Waronker, JD, Senior Partner and CEO of Informed Family Financial Services.
Myth: Pensioners don’t get Social Security
Private pensions, for clients fortunate enough to receive them, won’t impact Social Security benefits a bit. Employers provide them at an additional cost, and they and their employees still pay Social Security taxes.
Matters are more complicated for public sector workers. The Windfall Elimination Provision reduces benefits based on the number of years a pensioner still paid into Social Security; the more years, the lower the reduction. With some exceptions, the Government Pension Offset also reduces spousal benefits by two-thirds of the pension amount.
In general, though, most pensioners are still entitled to some Social Security benefits.
“I’ve worked with a lot of people who’ve left money on the table,” says Chris Hensley, President of Precept Wealth Management. “The average teacher, if they’re contributed to Social Security at some point, still might get $300 or $400 per month. Take that over the next 20 to 30 years with the cost of living adjustment, and that’s tens of thousands of dollars.”
Myth: Social Security isn’t taxed
It may come as an unpleasant surprise to some beneficiaries, but Social Security has been taxable since 1984. As of 2017, benefits are taxed at 50 percent for joint filers with incomes between $32,000 and $44,000, and 85 percent for couples earning more.
Even so, Social Security is more tax-efficient income than most retirement accounts. “This is one of the main reasons you should contribute to a 401(k),” says Waronker. “It comes off bottom line AGI [adjusted gross income], and you’ll probably be in a lower tax bracket when you retire.”
Contributions won’t impact clients’ earnings records and future Social Security benefits, but they will make it more feasible to delay benefits between retirement and age 70. By drawing down a sizeable 401(k) early in retirement, they can reduce their required minimum distributions and live primarily on a larger, less taxable Social Security benefit later on.
Myth: The cost of living adjustment will account for inflation
“To believe the COLA [cost of living adjustment] will keep pace with the actual increase your personal costs is a bit of fallacy, especially for an older person,” says Arthur. Social Security’s COLA is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), not the CPI for the elderly (CPI-E). The CPI-W emphasizes transportation, education, entertainment and food and is heavily influenced by energy costs.
Seniors, on the other hand, face the greatest inflation in their health care costs. Even if the adjustment does climb above its recent historic lows, the Medicare Part B premium increase can legally be as high as the average COLA dollar amount, completely offsetting any gain. The bottom line? As useful an income stream as Social Security is, clients should probably count on other income sources to cover its decreased spending power in the years to come.
Myth: Social Security is going broke
An evergreen topic for pundits and politicians, Social Security’s solvency is a growing concern among seniors. But the program is not going broke. “The reality of the situation is they have sufficient funds to pay benefits in full until 2034,” says Arthur. “Given the way our government is, though, it’s not going to get serious about solving the problem until 2033.”
Even if nothing were done, the shortfall would only be about 20 percent, and there are multiple ways to address it. Congress solved the same problem in 1983 with the most recent payroll tax increase, and according to the Trustees’ report, another 2.66 percent bump (1.33 percent each for employers and employees) would address the deficit for about 75 years. Other options include an increase in the full retirement age, investment of funds and elimination of the FICA cap. None of these options are extremely popular, but they’re all far more feasible than actually reducing senior voters’ benefits.
Myth: I won’t live long enough to make filing late a good decision
“People don’t look at longevity risk enough, and in making their Social Security decisions, they’ll look at their parents and grandparents and assume they’ll only live to 75 or 80,” says Waronker. While the average U.S. life expectancy is 76 for men and 81 for women, those figures rise to 84.3 and 86.6, respectively, for those who live past 65. What’s more, one in four of today’s 65-year-olds will live past 90; one in 10 past 95.
Comparing collection at ages 62 and 66, 62 and 70 and 66 and 70, the maximum break-even ages are 78, 81 and 83, respectively. It makes sense, then, why boomers who are considering only their parents’ longevities would think it was wise to collect at FRA or earlier. Considering the average retiree’s chances of living well into their 80s and 90s, however, delaying collection almost always makes sense.
Myth: Social Security isn’t an important part of my retirement income
While many Americans over-rely on Social Security, higher net worth clients – and even their advisors – often undervalue it. “When I speak to groups, I ask how much they think Social Security is going to pay them over their retirement, and nobody says it’s over $500,000,” says Ahluwalia. “For a typical upper middle income couple, it can easily be $1 million, and it’s typically their largest retirement income stream.”
Now that corporate pensions have gone by the wayside, Social Security is also most clients’ only lifetime guaranteed source of income. “People look at their 401(k) and IRA weekly, but they rarely look at Social Security,” Ahluwalia adds. But given Social Security’s unique tax status, government backing and guaranteed growth, clients who want to maximize their retirement income and preserve their assets can’t afford not to make the most of it.
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