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Like this article? Listen to Rande's related audio.  Social Security Questions & AnswersRecorded June 23, 2009 Social Security: Making the Most of Your Benefitsby Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial ResearchMay 27, 2009 Whether you are approaching retirement or already retired, you probably have some questions about how to maximize your Social Security benefits. Here are answers to some important frequently asked questions: Are Social Security payments based on average lifetime income? Social Security benefits generally are based on the average of your 35 highest years of earnings. Years in which you had low earnings or no earnings can be counted to bring the total years of earnings up to 35. That said, keep in mind that most people need 10 years of work (40 credits) to qualify for benefits. I will turn 62 soon. If I wait to start Social Security until age 66 I will have missed out on four years of benefits that I could have invested. Doesn’t it make sense to take the money early? The answer depends largely on how long you expect to live. Starting Social Security early reduces your benefits, but it also means you'll receive monthly checks for a longer time. On the other hand, starting Social Security later results in fewer checks over your lifetime, but those checks will be larger. Theoretically, it shouldn’t matter when you start as long as you have an average life expectancy. But, in reality, about half of us will live longer than average. There is a breakeven point at which it can make sense to wait. A big factor in your decision is how long you expect to live. There is no way to know for sure, but if you’re in good physical shape, don’t have any chronic illnesses or bad habits, and have a history of longevity in your family, then the general rule of thumb is that you should wait as long as possible to collect benefits. You will receive your largest benefit by delaying retirement until age 70, so it never makes sense to wait past that age. If you don’t expect to reach average life expectancy, then it might be better to take the money early. Just don’t forget to consider your spouse. If your spouse earned less than you did during your working lives, and you expect that your spouse might live longer than you, then think about whether it makes sense for you, the higher-earning spouse, to postpone benefits as long as you can in order to maximize your spouse’s Social Security survivor benefits. Is it true that if you start taking Social Security at age 62 the monthly amount will automatically increase once you reach full retirement age? For benefit purposes, the Social Security Administration (SSA) defines the full or normal retirement age (NRA) as between 66 and 67 for people born in 1943 or later. If you start collecting benefits before your NRA, that will result in a permanent reduction in your monthly Social Security check. SSA will give you an annual cost-of-living increase, but that’s it. I am retiring early and want to avoid going back to work. I am almost 62, debt-free and will have enough to live on if I take Social Security early. Should I take Social Security early and avoid tapping my 401(k) and IRA? There are a couple of moving parts here. In isolation it can make financial sense to postpone receiving Social Security as long as possible—assuming you have the discretion to do so, are in good health and expect to beat average life expectancy. Also in isolation, it’s generally best to postpone tax-deferred account withdrawals for as long as you can. That leaves taxable-account money, which is typically the preferred place to start, all else being equal. But if you need extra money to live on at age 62 and the only choice is between taking early Social Security or tapping tax-deferred retirement accounts, then you need to crunch the numbers to see what makes sense. Basically, it depends on how much return you expect to earn on your tax-deferred investments, such as your IRA and 401(k). The higher the expected return, the more sense it makes to leave that money alone and take early Social Security for the additional cash flow you need now. The level of return that favors going one way or the other will vary depending on the facts and circumstances—your benefit and life expectancy, for example. For someone who expects to live a long life, an expected return on tax-deferred assets below 5% or so would likely favor postponing Social Security for as long as possible, while an expected average annual return on tax-deferred accounts above 5% would generally favor taking the early Social Security and postponing tax-deferred account withdrawals for as long as you can. I have heard something about repaying the Social Security Administration for benefits I’ve already received and then restarting benefits later at a higher amount. Is this possible? Does it make sense? It is possible. If you previously elected to receive early Social Security benefits at a reduced rate you have the option of paying back to the government what you’ve already received and then restart benefits at a later date to take advantage of a higher payout. For example, let’s say you elected to receive early benefits at age 62 and you’re now 65 and thinking of going back to work. You could stop receiving Social Security, pay back the three years’ worth of benefits you received, go back to work, and then wait until age 70 to restart your benefit checks at a higher level. (You will receive your largest benefit by delaying retirement until age 70, so it never makes sense to wait past that age.) Paying back prior benefits is similar to buying an annuity, except that you don’t have to pay any interest on the benefits you’ve already received and there are no fees. As to your second question—whether it makes sense to take advantage of this option—it depends on your tax situation, your age and life expectancy. Of course, you also have to come up with the repayment money. You might want to enlist the help of a certified public accountant (CPA) or another financial professional to help you crunch the numbers. For important details about repaying benefits please read the SSA publication, If You Change Your Mind. If you determine that it makes sense for you to repay your benefits, you can get the process going by filling out Form 521, Request for Withdrawal of Application. I'm already collecting Social Security. How will going back to work affect my benefits? If you haven’t yet reached your full or normal retirement age (NRA is between 66 and 67 for those born in 1943 or later), earning a wage could reduce your benefits. For example:
Are Social Security benefits taxable? Your Social Security benefits may be taxable, depending on your modified adjusted gross income (MAGI). As your MAGI increases above a certain threshold (from earning a paycheck, for instance), more of your benefit is subject to income tax, up to a maximum of 85% of your benefit (see below). For details about taxation of your benefits see IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. Is it true that non-taxable income (such as Roth IRA withdrawals or municipal bond interest) is included when determining income to calculate taxes on Social Security payments? Not all non-taxable income is included in the calculation. Up to 85% of your Social Security benefit could be taxable, depending on your modified adjusted gross income (MAGI). Your MAGI is your regular adjusted gross income plus any tax-exempt municipal bond interest you earned. You don’t have to pay federal income tax on the muni bond interest—it’s just being included for purposes of calculating the tax on your Social Security benefits. Roth IRA withdrawals are not included in income for the purpose of figuring the tax on Social Security. But any taxable money you withdraw from a traditional IRA (or convert from a traditional IRA to a Roth IRA) is included in your regular adjusted gross income and so would affect the taxability of your Social Security benefit. After you calculate your MAGI, add half of your Social Security income to it. Once you have calculated your income as described above, see the table below to find out what percentage of your Social Security benefit is taxable.
For more information please see IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. I will be 66 in 2½ years and my wife will be 64. She will collect on her earnings record at age 62. At age 64 she will want to collect half of my Social Security benefits. I have tried to figure the amount, but I am not sure. I will be receiving about $2200 per month at age 66. Can you tell me how much my wife will receive when she is 64? If you begin collecting Social Security at age 66, your wife would then be eligible for 50% of your benefit. But, assuming her full retirement age is also 66, she would incur a 13.33% penalty because she would only be 64 when you start receiving your Social Security. There is a potentially better strategy, sometimes called the “62/70 split,” where the lower-earning spouse begins drawing at age 62 based on his or her own earnings record, and the higher-earning spouse waits until age 70 in order to receive the maximum benefit. Assuming both of you expect an average life expectancy, or greater, this strategy will generally maximize your Social Security cash flow over both of your lives. Keep in mind that, once both you and your spouse reach age 65, the odds of at least one of you reaching age 90 are greater than 60%, on average. So, as the higher wage earner, it could make sense for you to postpone benefits for as long as you can, up to age 70. We recommend that you check with the Social Security Administration to be sure about the details in your particular situation. Meanwhile, the SSA's What Every Woman Should Know has some good information about spousal benefits. As always, if you have questions or need help, please contact your Schwab consultant. If you're not yet a Schwab client but would like to learn more, a Schwab consultant can help. Call 800-435-4000 to get started. Important Disclosures The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve. Links to third-party sites made available herein are for your convenience only and is provided through providers that are considered reliable sources. However Schwab cannot guarantee the accuracy, completeness or reliability of the content maintain on those third-party sites. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. (1009-10477) Return to Top |
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