Planning for social security benefits has apparently become a hot topic for many readers. Buying into the idea that social security will be broke in x number of years, some people discount the future value of their benefits. For others, it will be such a small part of their overall retirement success that it doesn’t warrant much ink. But I suppose that because there are many readers getting close to retirement age, questions regarding social security appear frequently in my inbox.
The most common question, and the one that has the greatest long term impact, is “When should I start my benefits?” Just as a reminder, you can start a reduced benefit at age 62; the age for receiving “full” retirement benefits is set by the year of birth and can range from age 65 to age 67; and one can receive an increased benefit up until age 70. It makes no sense to go past 70 to start benefits. For married couples, spouses have so many potential yearly combinations of individual start dates that careful and complete analysis is in order.
A few years ago, Wharton School of Business published a research paper on the choice of a start date. They concluded that the selection of start date was often behaviorally determined and directly related to how the problem was framed. Not too surprisingly, those prospective recipients who viewed the question from a break-even analysis almost always opted for an earlier start date. Comparing age 62 to age 70, the breakeven age is generally about 78. Those for whom the question was posed around lifetime benefit chose a later start date. We are of the opinion that a better analysis is quantitative and optimizes start date for both spouses down to the month and year.
One of the first things to understand when you are thinking about starting benefits is that after the death of the higher-earning spouse, the higher benefit will transfer to the surviving (lower-earning) spouse. The surviving spouse’s own benefit will then stop. Thus, the start date of the higher-earning spouse will determine the lifetime benefit for both of them. Choosing a later start date is like procuring a life insurance policy that will pay out over the lifetime of the surviving spouse. This points to one fallacy of a breakeven analysis. Many people look at the breakeven date and conclude that because their life expectancy is not much greater than the breakeven date, they should opt for an earlier start date. They do this without considering the impact to the surviving spouse. When you are married, you should consider the potential life expectancy of the longer-lived spouse. This could become especially important for couples with an age-gap between them and where the younger spouse is the lower-earner. Remember, the higher earner’s benefit will prevail regardless of who dies first—that benefit should be maximized. The lower earner’s life expectancy becomes the controlling factor if the financial security of the surviving spouse is your concern.
Obviously, there is a cost to waiting to start benefits. If both spouses die early, the delayed claiming strategy would cause them to have foregone the benefit that could have been received between age 62 and the later start date. This amount is the “cost” of the longevity insurance (if the higher earner lives to a very old age) and life insurance (if he or she dies early). Worth noting that this cost goes away if the lower-earner lives past the breakeven point.
In many cases, the optimized solution reveals that the higher-earning spouse should file for benefits and suspend their receipt in order for the lower-earning spouse to collect spousal benefits. Yes, this can actually be done. Also if, like me, you were older when your child was born, filing and suspending may enable a minor child to collect a benefit until he or she reaches age 18. In both cases, the benefit of the one who suspended continues to grow. The bottom line is that family demographics matter and each spouse should carefully consider the life-expectancy of the other before claiming his or her benefits.
So far, we have dealt with the cumulative benefits of Social Security and it’s easy to dismiss the large numbers that are included in such an analysis; but in reality most benefits are not accumulated, they are spent on living expenses throughout retirement. To a surviving spouse, the income is likely to be the factor that ultimately matters the most. Imagine if you will, 40 years from now, your spouse is sitting with his or her friends in the retirement community comparing social security checks. As tempting as it was to start earlier, the impact of delaying the start of benefits is clearly evident as the one who delayed the start date has nearly twice as much in benefit as one who started at age 62. The survivor benefit includes all the delayed credits accrued between full retirement age and age 70 plus the cost of living increases that compounded on the higher starting amount. It’s hard to value the peace of mind that comes from a having a source of lifetime income as one gets older.
Your financial advisor should routinely build this analysis into your financial plans and make recommendations regarding the optimized start date. The analysis can also be performed on a stand-alone basis with a minimum amount of data. In any event the final decision is a very personal one, uniquely tied to individual circumstances, and the impact can be big. It should not be left up to rules-of-thumb, and certainly not to mere chance.
THE MOST COMMON QUESTION, AND THE ONE THAT HAS THE GREATEST LONG TERM IMPACT, IS “WHEN SHOULD I START MY BENEFITS?”
Scott Neal, CPA, CFP is President of D. Scott Neal, Inc., a fee-only financial planning and investment advisory firm with offices in Lexington and Louisville, KY. Email questions to scott@dsneal.com.