Optimizing Social Security Benefits

(This article is adapted from Doug Keegan’s "Making Cents" segment on this week’s Lincoln Radio Journal which can be heard at [L]www.lincolnradiojournal.com[EL].)

When your parents or grandparents retired, they probably didn’t think too much about Social Security. They just went down to their local office, applied for benefits and didn’t ask too many questions. Not so for the baby boom generation. Fearing that their benefits will be cut, many boomers are planning to collect early. But collecting early may cost you. Here to explain is Doug Keegan of Harris SBSB.

Doug, before we get started, I read last week that there will be no cost-of-living adjustment next year for Social Security recipients. Is that true?

Yes and here’s why. Each October the Social Security Administration announces a cost-of-living adjustment for the following year. That adjustment is based on the Consumer Price Index. For the previous 12 months, ending September, consumer prices actually fell 1.3%. So, for the first time since automatic adjustments were adopted back in 1975, Social Security recipients will not receive a benefit increase. In light of this, the Obama administration is supporting a second round of $250 stimulus payments to help those who depend on Social Security benefits.

Getting back to our topic, why are baby boomers approaching Social Security differently?

It’s simply this – they’re worried about the future of Social Security. Many think, why should I wait to see what happens? I better collect as soon as I can. But that attitude, which is based on fear, may cost them in the long run, particularly for married couples, where one spouse has a 50% chance of living to age 90. To provide context, let’s talk about previous generations. While it’s true that many older Americans did take early benefits, it’s also true that they faced different circumstances. They had shorter life expectancies and many had little in retirement savings. So it made financial sense to collect early. But with boomers it’s different. They want it now because they don’t think they’ll get it later. That represents a fundamental shift in attitude. But with rising life expectancies and changes in the workplace, boomers may be shortchanging themselves despite their fears.

But aren’t their fears substantiated? Isn’t Social Security bankrupt?

It’s not bankrupt, but there’s no question it’s on an unsustainable path. Yet it can be fixed. My concern is – do we have the political will to fix it. Here are the numbers. According to the 2009 Trustees Report, the Social Security trust fund is expected to grow a surplus of nearly $4 trillion by 2016. While that sounds good, in reality that $4 trillion surplus is really in the form of loans to the U.S. Treasury. In 6 years, when Social Security benefit payments exceed payroll taxes, the Social Security Administration will have no choice but to start cashing in a portion of those loans. The problem is the U.S. Treasury doesn’t have the money. Congress spent it. So to make good on those loans, our federal government will either have to increase payroll taxes, cut programs, sell assets, or borrow it. Absent reforms, by 2037, the Social Security surplus will be drawn down, with payroll taxes covering about 75% of projected benefits.

So the situation isn’t good, but we’re not bankrupt, yet. Should baby boomers be concerned? Absolutely, they have every right to be concerned. But should they collect early based on that concern? Let’s do the math. If you’re 62, according to the 2009 Trustees Report, you’d be 90 before seeing a benefit cut. Moreover, most reform proposals protect those 55 and older from cuts. So instead of cutting benefits, Congress most likely will raise payroll taxes and increase the wage base subject to payroll taxes. So its younger workers like me who will pay more into the system with little to no hope of seeing much in return.

Doug, you mentioned that it’s especially advantageous for married couples to delay benefits. Why?

Lowman, we’re living longer. And it pays to delay if you live well into your 80s. For married couples, it’s especially important to delay because of something known as joint mortality. For example, consider a husband and wife age 62. According to the Social Security Administration’s 2005 Mortality Table, looked at individually, the husband’s life expectancy is age 82 while the wife’s life expectancy is age 85. But when you put them together and look at their joint mortality, there’s a 50% chance one of them will live to age 90. Therefore, the goal must be to maximize benefits for the surviving spouse. Remember, the surviving spouse will get 100% of the deceased spouse’s benefit. Now the analysis can get quite complicated, but by understanding all of the considerations and doing some calculations, it’s possible for married couples to come up with the right solution for their needs.

How are benefits increased if you delay?

When it comes to Social Security, you have three choices – take it early, wait until your full retirement age or wait even longer. Let’s start with full retirement age. Full retirement age is the age at which you may begin receiving your full, unreduced benefit. For most baby boomers that means age 66. For those wanting to collect early, eligibility starts at age 62, but you’ll have to take a haircut on your full benefit. That means up to a possible 25% reduction in benefits. Now for those wanting to delay benefits past age 66, you can. And for each year you delay, your benefit will increase by 8% up to age 70, after which no further credit may be earned.

Altogether, the value of deferring benefits rises by 76% in the eight years from age 62 to age 70. So, as you can see, the age at which you apply for benefits will significantly impact your monthly income and the total amount of benefits you’ll receive over your lifetime. Knowing at what age you’ll break even and begin to come out ahead if you delay benefits is crucial in determining when you should apply for Social Security.

So how do I determine my break even age and when should I apply for Social Security?

Unfortunately, there’s no one size, fits all answer. There are a number of web-based calculators out there and those calculators can help you determine your break even age, but they mainly focus on maximizing individual benefits, not spousal benefits. The analysis for married couples can get quite complicated. And as I’ve pointed out before, it’s precisely married couples, not individuals, who stand to lose the most by not optimizing their benefits. At my firm, we’ve built a Social Security calculator that can help married couples optimize benefits. But whether you use our calculator or a web-based calculator, the decision must first begin with an analysis of your personal circumstances and financial situation.

Apart from personal circumstances, however, the basic premise is this: (1) if you apply early, you’ll receive more checks but in a smaller amount, (2) if you apply later, you’ll receive fewer checks but in a higher amount. At what age you’ll break even and begin to come out ahead will depend on the amount of your benefits, the assumptions you use to account for taxes, and the opportunity cost of delaying benefits. Once you determine your break even age, the choice simply comes down to how long you expect to live. When I run the numbers using basic assumptions, the break even age falls somewhere between age 76 and age 84. So if you think you’ll live well into your 80s, delaying benefits might pay off.

So wrapping up, can you give us some basic rules of thumb for married couples?

First and foremost, optimize the surviving spouse’s benefit, taking into consideration factors like life expectancy, health status, and financial resources. Ideally, the higher-earning spouse should delay benefits to age 70 while the lower-earning spouse should file for benefits at age 66. This strategy should, on average, yield the greatest lifetime benefits. But again, it depends on your life expectancy and financial resources.

By delaying benefits to age 70, the surviving spouse will get a 32% benefit increase plus cost-of-living adjustments. That’s significant. And that higher benefit can serve as a form of longevity insurance, just at the time when the surviving spouse may need it the most – late in life.