Social Security Planning Strategies

Allen McLellan LUTCF, CLU®, ChFC®, CASL®, CFP®

Adjunct Professor of Insurance

Disclaimer • The material included in this presentation is not offered

as legal or tax advice. Information and examples to illustrate tax concepts are based on published IRS guidance as of August 1, 2013, and are subject to change.

• You are urged to seek the advice of your tax advisor, attorney, and/or financial planner for guidance in your individual circumstances.

• All material is presented solely as educational information and is not a solicitation or offer of any products or services.

Social Security Strategies • “The age at which an individual chooses to

start Social Security retirement benefits can be arguably the most significant factor in his or her ability to maintain financial security throughout retirement.”

• Tacchino, Littell, and Schobel, “A Decision Framework for Optimizing the Social Security Claiming Age,” Benefits Quarterly, Q2/2012.

Social Security Planning Strategies

• But first some basics…

Good News--Living LongerBad News--Living Longer!

Social Security Planning Strategies

• Q:What is Social Security?

• An inflation-adjusted stream of payments for life…a life annuity with COLA!

• Social Security = “Longevity insurance”

Social Security • What does the average client know about it?

– Very little!

• How does the average worker decide on a start date for retirement benefits?– Casually…for most!

• 50 percent or more begin retirement benefits at 62…– A bad decision for most!

Eligibility for Retirement Benefits• 40 coverage credits – “fully insured”

• In 2013, $4,640 in earnings, any time during the year, equals 4 coverage credits for the year.

• Spousal benefits for non-employed or lower earning spouses, based on worker’s PIA.

• Workers’ benefits are based on the 35 years of highest earnings.

• Planning Point: Continued work by a client may increase Social Security benefit amounts by “replacing zeros.”

Social Security’s Role—It’s a Big Deal!

• For 1 in 5 retirees Social Security is their only source of income.

• For 1 in 3 retirees Social Security is 90 percent of their retirement income.

• For 2 in 3 retirees Social Security is more than 50 percent of their retirement income.

• These ratios are not expected to change over time.

By the Numbers• 62- Earliest age to start S-S retirement $$• 60 – Earliest age to start widow(er) $$• $1,229/mo- Average, All workers <2012>• $1,994/mo – Average, couples, both retired <2012>• $1,184/mo – Average, widow(er) alone <2012>• $15,120/yr – Earnings limit prior to FRA <2013> • 70 – Max. age for deferred S-S credits

<ssa.gov>

Social Security Replacement Ratios for Retiree & Family

Primary Insurance Amount (PIA)• An eligible worker can receive at full retirement age a

monthly benefit of 100 percent of his or her PIA.- All benefits based on worker’s PIA

• Social Security benefits are indexed for wage growth.

 • Earnings at age 60 and older are not indexed.

• S-S Earnings are capped at the taxable wage base ($113,700 in 2013)

Primary Insurance Amount (PIA)

• Planning Point: Replacing a year with salary for a zero year will increase the benefit amount. Planners should encourage work that will replace low earning or “zero” years. Replacing a “zero year” with a year with earnings could result in roughly a 3 percent increase in the benefit. 

• Clients are typically not aware that their Social Security benefit is based on 35 years of earnings.

• Planning Point: A client who continues to work is not just working for his/her salary. The client may also be working for a “bump” in his/her Social Security benefit (not to mention the similar effect on any employer-provided pension benefit).

Deferred Social Security Credits• For those born 1943-54, each year delay

beyond full retirement age results in an 8 percent increase in benefits• Example:

– PIA = $1,000 (at age 66)– Benefit = $1,320 (at age 70)

• Planning Point: There is no reason to delay S-S benefits beyond age 70.

Early Claiming Age• A benefit is reduced 5/9 of one percent of the PIA for each month before full

retirement age up to 36 months.

• If the number exceeds 36, then the benefit is further reduced 5/12 of one percent of the PIA per month.

 • Example 1: Dan, who retires and claims benefits 3 years early, will receive a

monthly benefit 20 percent smaller than his PIA.

(5/9 x 36=20)

• Example 2: Jamie, who retires and claims benefits 4 years early, will receive a monthly benefit 25 percent smaller than her PIA.

(5/9 x 36=20) + (5/12 x 12=5) (total 25 percent).

 If Jamie would have received $1,500 per month at full retirement age, she would get $1,125 at age 62.

Deferred Claiming Age• In the case of a claiming age after full retirement age a benefit is

increased 2/3 of one percent of the PIA for each month for anyone born in 1943 and after.

 • Example 1: Connie delays one year beyond full retirement age. She will

receive a monthly benefit 8 percent larger than her PIA. (2/3 x 12 = 8)

• Planning Point: Every year the primary worker works past age 62 will normally result in an increased AIME, PIA and final benefit. Even without working, benefit at age 70 is 76% higher than age 62!

• Planning Point: There is no actuarial increase after reaching age 70. For this reason, there is no advantage to delay benefits once an individual reaches age 70.

Social Security Claiming Ages

Age 62 Age 63 Age 64 Age 65 Age 66 Age 67 Age 68 Age 69 Age 700

200

400

600

800

1000

1200

1400 76 Percent Increase

Maximum Benefit Amounts

Age Per Month Per Year

62 $1,875 $22,500

66 $2,500 $30,000

70 $3,300 $39,600

Taxation of Social Security

• Must watch out for the “TAX TORPEDO!”

Taxation of Social Security• Provisional Income =

AGI

+ Tax-exempt income

+ ½ of Social Security benefits

=================================

For Married Filing Jointly:

Under $32,000 - 0% SS is taxed

$32,000- $43,999 Up to 50% SS taxed

$44,000 and more Up to 85% SS taxed

Taxation of Social Security & The “Tax Torpedo”

• Planning Point: For middle-income couples drawing Social Security benefits and taking taxable withdrawals from retirement plans, the effective tax on the withdrawals can be as high as 46% per dollar!! This occurs because of higher percentages of Social Security benefits being taxed (50% or 85%) if provisional income exceeds thresholds.

The Claim Now, Claim More Later Strategy

• People who claim their benefits prior to normal retirement age will miss out on the “claim now, claim more later” strategy.

 • Claiming after full retirement age provides the recipient a

choice of either spousal or worker benefit.

• Planning Point: Under the “claim now, claim more later” strategy the client will choose the spousal benefit first, and defer the worker’s benefit until later –typically age 70.

Claim Now, Claim More Later• Bob, age 70, delayed filing for Social

Security retirement benefits to take advantage of delayed credits. His wife Brenda, age 66, could now file for spousal benefits (based on Bob’s work history) and delay filing on her own earnings history until she reaches age 70 ---to maximize her benefit with delayed credits.

The Claim and Suspend Strategy• Since, 2000 workers can start benefits at (or after) full retirement age

and voluntarily suspend them (and restart them later).

- Note, the strategy only works if the higher-earning spouse is at or beyond full retirement age.

• Planning Point: Claim and suspend enhances the options of one-earner couples or couples with a spouse with small Social Security worker benefits (worker’s benefits that are below the spousal benefit).

• Planning Point: Caution in exercising the strategy. Do it in person –with a knowledgable SS representative!

Claim and Suspend Strategy• John and Betty are both retired professionals with

significant work histories. John’s PIA is $2,000, while Betty’s is $1,800.They are both age 66, their full retirement age. John can “claim and suspend,” allowing Betty to file for spousal benefit of $1,000. She can delay taking her worker’s benefit until age 70, when the benefit will be $2,376 (1.32 x $1,800) due to her delayed retirement credits of 8 percent per year. John’s worker’s benefit will be $2,640 due to his delayed credits.

Claim and Suspend• “Claim (also “file) and suspend” also enhances the

claiming options for married couples and thereby increases their potential lifetime benefits.”

• “The wife’s survivor benefit, which she will receive once her husband dies (in 75% of marriages), depends on her husband’s actual benefit. To get as high a survivor benefit as possible, the husband should continue working as long as possible. Thus, the optimal claiming ages for the husband and wife are 70 and 62, respectively.”

[Munnell, Golub-Sass, Karamcheva: Strange But True: Claim and Suspend Social Security. BC–CRR, May 2009.

Choosing the Optimal Social Security Claiming Age

Suggested Model• Step One: Change client perceptions through an educational

program. Stress increased benefits from delay—rather than decreased benefits for early claims.

• Step Two: Assess funding adequacy, then either conduct a break-even analysis or a bridge-period analysis to select a claiming age.

• Step Three: Assess the client’s options under Social Security.

• Step Four: Integrate the claiming decision into a cohesive retirement income plan.

Education Program• To properly choose a claiming age, it may be necessary to change

client attitudes.

• Two faulty perceptions:

• The claiming age and the retirement decision are inexorably linked; they are not. In the vast majority of cases, the retirement age and the claiming age do not have to be the same.

• The client should avoid losing out on years of payments from Social Security. However, losing out on payments is a secondary concern to running out of money in retirement.

Separate the Retirement and Social Security Start Date

• Except where absolutely necessary because of lost work and no meaningful savings, the desire for a specified retirement age should NOT drive the claiming decision.

• Deferring Social Security claiming, even if retirement has begun, could increase retirement income substantially.

• A delayed claiming decision may be one of the few planning tools available to an individual with insufficient savings.

• Fiscal concerns for many may make the claiming decision more likely to be an “insurance by necessity” issue, and thus a delayed claiming age is typically the best alternative.

Free Money?• The concept of passing up “free money” at age 62 is a shortsighted

way to view a complex issue.

• The issue of when to claim is effectively an annuity purchase date choice, and purchasing a larger annuity at an advanced age absent, for example, knowledge of a terminal illness for a single client, will lead to greater insurance protection in the later years for the vast majority of clients.

• Planning Point: The “free money” that needs to be focused on is not the dollars of low marginal utility at 62, but the dollars of high marginal utility at advanced ages. Which is more important: a sailboat at 62, or food and shelter at 85?

Fully Funded Clients• The fully funded client & Social Security start date

• The fully funded client is most likely to frame the issue as a net present value break-even analysis. • “About 80” is the break-even point.

• Planning Point: Clients should be careful because a married person claiming early may leave the widow(er) with a permanently reduced benefit.

Partially Funded Clients

• Marginally or underfunded clients—portfolio failure in later years!

• Deferring Social Security and replacing the lost income from earnings from employment should be a strong consideration.

• Some will not have the option of continuing to work. Planners will often find this to be the most effective solution for marginally funded or underfunded clients.

• Planning Point: In this case the claiming-age analysis will entail an analysis of a how best to deal with the bridge period-- the period between the discontinuance of a paycheck and the commencement of Social Security,

The Break-Even Approach

• For some clients the claiming-age decision is a net-present-value break-even choice that attempts to maximize the net worth a client can achieve.

• Might be correct for clients not in danger of sacrificing their standard of living in the later years of retirement.

Break-Even Assumptions Used• Discount rate (huge factor!)

• Personal life expectancy

• The earnings test

• Taxation of Social Security

• Spousal survivor benefit opportunity

• COLAs

• Expenses

Lots of moving parts!!

Good Luck!

Insurance Against Longevity Risk• The period between the discontinuance of a paycheck and the

commencement of Social Security is sometimes called the bridge period.

• Each month of deferral during the bridge period is like buying an additional inflation-adjusted life annuity.

• Planning Point: Planners must balance the reduction in other retirement assets against the increased Social Security “annuity.” The balancing act is between taking higher income from retirement savings versus taking higher income from Social Security.• These are “what if” comparisons with F.P. software

Reasons to Delay Social Security

• There is a “snowballing” effect on delaying S-S benefits because of both the actuarial increases and the compounding of COLA increases.

• The “reverse tax torpedo” if S-S benefits are taken later because only one-half of Social Security benefits are included in the calculation of provisional income.

• Some of the investment risk has been transferred by a delayed claiming because you are replacing income from 401(k)/IRA assets with S-S annuity income. Treat S-S as “bond portion” of portfolio.

• There is less money being paid to investment expenses since assets are consumed earlier in a trade-off for higher Social Security benefits.

Reasons for Early Claiming Age

• There is a loss of liquidity because in most cases the retiree will need to consume retirement assets early.

• The desire for leaving assets to heirs is jeopardized because in most cases the retiree will need to consume retirement assets early.

• The rate of return net of taxes and expenses that could be earned on invested retirement savings may outperform the higher Social Security annuity.

Why the Break-Even Viewpoint is Flawed• The fundamental concern is an adequate retirement income. The break-

even age method ignores how the Social Security claiming-age decision fits into the bigger picture of retirement income security. Can’t be “efficient” is not first “effective.”

• The break-even method is an ineffective way to frame the problem, because researchers indicate that choosing a different discount rate may change the results of the analysis.

• Planning Point: The break-even method induces people to think about the problem incorrectly. For example, the break-even method is an ineffective way to frame the problem, because research shows that only if life expectancy is long or short does the commencement decision significantly affect wealth.

The Premise• For many clients, delayed claiming based on the need

to capitalize on the insurance value of Social Security and the need to protect against portfolio failure (running out of the money needed at the end of retirement to maintain the desired standard of living) leads to the question: Is delayed claiming the best way to accomplish this goal? They might better ask if taking an early claiming and preserving other assets (e.g., 401(k) assets) is the better way to provide for the later years of retirement.

The Social Security Annuity• Social Security is the cheapest and best annuity available.

• Social Security is inflation adjusted in a way that no private annuity is (full CPI protection).

• Social Security does not have loads or fees.

• Social Security is guaranteed by the government.

• Buying longevity insurance should not be considered a bad decision before the fact, even if the individual happens to die early.

What the Research Reveals

• Unless the 401(k) gets astonishing returns, the delayed Social Security benefit option will be better despite the liquidation of 401(k) assets.

The Planner’s Challenge• It is a “battle” to change client perceptions.• People perceive that Social Security is going

away.• There are uses of money other than income. Can

you spell C-R-U-I-S-E?• Clients need a rational way to decide to what

extent they need an income stream or a liquid fund.

• These are legitimate and competing interests.

Impact on Systematic Withdrawals

• Delaying, even though liquidating assets, allows the asset portfolio to last longer!

• A 2-year delay raises the portfolio longevity to 91.

• A 4-year delay raises the portfolio longevity to 93.

• Waiting to 70 to claim Social Security benefits will initially reduce the portfolio in half. But the 76 percent higher (age 70 vs 62) benefit will make the portfolio last longer.

Social Security Changes• The winds of change are blowing for Social Security.

• Change may grandfather in people in, or near, pay status.

• Planning Point: Social Security must change in the next 25 years.

• Changes will probably include revenue increases (new taxes) and benefit cuts.

• Increases to the normal retirement age are the most probable change.

Social Security Changes• An increased normal retirement age will lower the level of benefits at every age in

the continuum (62-70).

• If we are talking about a break-even, the thought process will remain unchanged. If we are talking about getting a basic income, clients will have to work longer and delay claiming.

• Even if the overall level of Social Security benefits is reduced, the claiming-age decision will continue to remain important.

• The ratio of what you can get to what you need will change and push clients to claim at a higher age.

• Planning Point: The “insurance framing” of the claiming-age decision becomes more important if future Social Security benefits are discounted.

Calvin & Doris• Case #1: Calvin and Doris, both aged 62, married

for 35 years. Calvin worked for the entire marriage. Doris never worked outside the house raising children. Full retirement age is 66 for both. They have the risk of funds running out, or their standard of living being compromised prior to death. Calvin’s PIA is $1,800. Doris does not have enough quarters of coverage to qualify for worker benefits under Social Security.

Calvin & Doris

• Even if Calvin is retired from his job, he should

seriously consider deferring his claiming age.

• Calvin should use the claim and suspend strategy at full retirement age (FRA) (FRA is 66 for both). This will enable Doris to start a spousal benefit equal to 50 percent of Calvin’s PIA.

• Calvin will continue to accrue deferral credits until age 70. His monthly benefit will be $2,376 at 70, assuming no additional years of earnings. This will help to both lengthen their portfolio longevity and provide for the largest possible widow’s benefit if Doris outlives Calvin. Note: Wives survive husbands in 75% of marriages!

Grace & Harry• Case #2: Grace and Harry have been married for 40 years. He is age 66; she is age 63. He has worked out of the house his whole life and plans to continue working as an accountant until age 70. She worked out of the house for only 15 years after the children were gone; she will also continue to work until age 70 as a social worker. His PIA is

$2,000. Her PIA is $700.

Grace & Harry• (Harry could receive unreduced benefits at full retirement age even though his salary

exceeds the earning test threshold because the earnings test does not apply after FRA.) If Harry plans to maximize credits for delaying, Harry should use the “file and suspend” strategy when he turns 69 so that Grace can start a spousal benefit at 66. (Before full retirement age for Grace, her spousal benefit would have been lost to the earnings test).

• Grace will continue to accrue credits even though her worker benefit (1.32 x 700 = $924) will not be as high as her spousal benefit (50 percent of $2,000 = $1,000). However, be aware that her PIA can continue to grow and her worker benefit could exceed her spousal benefit if she earns enough as a social worker.

• By waiting until age 70, Harry has provided the largest possible survivor benefit he could for Grace (1.32 x $2,000 = $2,640, possibly higher if Harry’s PIA was impacted by continuing to work).

Good Info Sources

• www.TheAmericanCollege.edu/NYLCRI• www.TheWealthChannel.com• www.ssa.gov• Boston College Center for Retirement

Research– www.bc.edu/crr