ROAD TO RETIREMENT
CHAPTER 3: When Should You Begin Taking Social Security?
Working in the retirement planning business, I get to hear all about people’s expectations on what they think retirement will be like for them. Their travel plans overseas, their planned time with their kids and grandkids, or their leisure time on the golf course or boat. Of course, all of these plans require income. But where will that income come from?
Social Security is the most common source of retirement income that exists in America, yet many people seem to vastly underestimate its impact on their long-term financial health. Most have a hard time understanding the nuances of how to best file for Social Security in a way that maximizes lifetime income.
There are countless ways to file for Social Security, and you will likely only get one shot at getting it correct. There are no “do-overs” once you make your election, except within the first 12 months, if you're willing to pay back 100% of the already-received distributions. As I have seen too many times, taking your benefit too early can be a big mistake you will suffer from for the rest of your life!
How do you know if you are making the right choice when you file? I suggest you spend as much time as possible educating yourself before you make your election, as this is not a decision to take lightly. Unfortunately, far too many may assume they can run down to the local Social Security office and meet with an expert to help them choose the best strategy. However, the Social Security Administration's own rules prohibit them from giving you any detailed custom advice. They are only permitted to help you file for your benefits and answer basic questions. That means if you truly want to get the most out of Social Security, you will need to educate yourself or talk to an experienced professional, like a financial advisor.
One common misconception is that when someone retires, they should immediately start collecting Social Security benefits. Another misunderstanding is that people “qualify” for Social Security at age 65, the same time they qualify for Medicare.
But the moment you retire and the date you choose to start receiving Social Security are not always the same. And similarly, Social Security doesn't necessarily have to coincide with when you draw Medicare. In truth, there’s more to the timing than you may think — and the decision could greatly impact your financial situation.
Here’s what you should know about collecting Social Security in retirement, and how timing it right can benefit you throughout your golden years.
How much you can collect in Social Security benefits depends on your work earnings history and your age
The amount you receive from Social Security benefits will be based on your earnings record and the age when you file for your benefits. While there’s not much you can do to change your prior earnings, there’s actually something you can do about how much in total benefits you can receive. If you choose to begin receiving benefits later in life, then you may be able to increase your monthly benefit. If you choose to receive your benefit later and you live to your assumed life expectancy, the additional cumulative lifetime benefit may be significant.
The first thing you’ll want to know is what the Social Security Administration calls your Full Retirement Age, or FRA. This is the age at which you can claim your standard retirement benefits.
Your Full Retirement Age depends on your birth year. For example, if you were born in 1954 or earlier, your FRA is 66. For every year after, you would add two months to your Full Retirement Age. Following this formula, if you were born in 1955, your FRA is 66 and 2 months. The maximum full retirement age is 67 for anyone born in 1960 or later.
Knowing your FRA is important because you won’t receive your full benefits if you start collecting too soon. While you can certainly file for Social Security as early as age 62, your benefits will not be as high as if you choose to wait and start receiving your benefits past your FRA.
The reduction for collecting Social Security early depends on how many months before your FRA you choose to file. Your benefit is reduced by 5/9 of 1% for every month before your FRA, up to 36 months. Each additional month reduces your benefit by 5/12 of 1%. The math may sound complex, but it goes like this: Filing at the earliest possible age, 62, would cause a 30% reduction in benefits for someone with an FRA of 67, which means leaving a lot of money on the table.
Wait if you can, but don’t wait too long
If you have enough income from other sources to cover your needs until you are older, then it can be beneficial to delay filing to increase the size of your monthly benefit. For every month you wait to file after your Full Retirement Age, your benefit is increased by 2/3 of 1%. This works out to an approximate 8% increase in your monthly benefit per year!
For example, someone with an FRA of 67 could increase their benefit by about 24% simply by waiting until age 70 to start receiving benefits. But don’t wait too long — in fact there’s no reason to wait beyond 70, because your delayed benefits will no longer accrue past that point.
If you’re interested in seeing your estimated Social Security benefits, then you can use the Social Security Administration’s nifty Retirement Estimator to see how much of an impact your age depends on your future benefit.
Don’t assume you’ll be able to work in retirement; it may not be a safety net
In my experience, many people who are close to retirement may plan to work at least part-time when they leave their careers. In fact, according to the Employee Benefit Research Institute, 72% of current workers expect to work for income during retirement. But the truth is that only about a quarter of retirees today actually end up working.
You may not even have a say in how long you’ll be able to work at all. Things outside of your control, like your health, may require you to stop working — in fact, a medical condition is the number one reason people are unable to work as long as intended.
Don’t put your entire retirement plans in jeopardy by assuming you’ll be able to earn the income you’ll need during your retirement years. While it’s okay to include work in your plan, it’s best not to have to depend on it for income. Any pay derived from working should ideally be supplemental.
Reductions to Social Security benefits for working retirees
You may think that you can maximize your income by working in retirement and simultaneously collecting Social Security benefits. While it sounds like a good plan, working could actually reduce your benefit if you exceed certain income levels from employment.
There is an earnings limit that applies to the few years before you reach Full Retirement Age, and another limit for the year you are at FRA. Incomes above these published limits trigger a reduction of benefits.
- For 2021, the earnings limit for the years before you reach full retirement age is $18,960. Your Social Security benefit is reduced by $1 for every $2 you earn above that amount.
- If you reach Full Retirement Age in 2021, then the earnings limit is $50,520. Your benefit will be reduced by $1 for every $3 you earn above that, prorated on a monthly basis.
The good news is if your benefit is reduced due to your earnings, then you won’t lose those benefits forever. Instead, any reduction will be added back to your monthly benefit once you reach full retirement age.
And if you’ve already applied for Social Security but decide you no longer need it, then you can choose to suspend your benefit. Doing so can be beneficial because you’ll earn delayed credits, just as if you’d waited longer to file.
Understanding spousal benefits
Your spouse can claim retirement benefits based on their personal earnings record, or they can claim a spousal benefit based on your record. I find that many retirees are unaware of that distinction.
Luckily, if your spouse claims a spousal benefit based on your record instead of receiving their own benefit, it will not reduce yours. This can be a simple way to increase your total family benefit if one spouse earns significantly more than the other. Both spouses can claim based on the higher-earning spouse’s record.
The basic spousal benefit is half of the primary worker’s benefit at full retirement age, called the primary insurance amount.
The spousal benefit is also reduced for filing early. For example, if the primary worker’s benefit is $2,000, then the spousal benefit is $1,000. Any reduction for filing early would be applied to the $1,000 spousal benefit.
Spousal benefits do not earn delayed credits, so there is no reason to delay them past Full Retirement Age.
Widows, widowers, and divorcees can receive a benefit on the deceased or former spouse’s record as well:
- Widows and widowers at full retirement age will receive 100% of the deceased person’s benefit. They can claim as early as age 60 for a reduced benefit.
- Divorcees can receive a benefit provided they are at least 62, unmarried, and were married for at least 10 years.
- Divorcees of a deceased spouse can continue to claim a survivor benefit if they do not remarry before turning 60.
How Social Security is taxed
Many retirees are surprised to learn that their Social Security benefits are often taxed. But yes, it’s true! The IRS wants a piece of your retirement pie, too. Understanding how they’re taxed ahead of time can help you avoid any surprises once you begin collecting.
One thing to note is that not all benefits are taxable. Depending on your income, none, half, or 85% of your benefit will be taxable. The higher your income, the higher the amount that is subject to income taxation.
The measure of income used to determine Social Security taxability is called your combined income. Your combined income is your adjusted gross income, plus the tax-free interest you received, plus half of your Social Security benefit.
The tables below show how the taxable portion of your Social Security benefit is determined by your combined income and filing status.
Single, Widowed, Married Filing Separately*
Married Filing Jointly
With proper planning, it may be possible to reduce the amount of benefits you’ll have to pay taxes on. The idea is to use careful planning to lower your combined income. If your income is low enough, you can avoid paying taxes on your benefit entirely.
One of the easiest strategies to reduce your combined taxable income during retirement is to hold as much of your retirement savings in Roth IRA accounts. Withdrawals from Roth accounts are not included in your adjusted gross income, they are not counted in your combined income.
By saving directly into a Roth IRA or employer-sponsored plan, or performing a Roth conversion leading up to retirement, you can take retirement distributions that won’t increase your tax bill on your Social Security benefits.
Retirement has its complexities, but you don’t have to manage them alone
Understanding the rules, regulations, and timing of your retirement can make all the difference in how life after work plays out for you and your family.
Planning in advance and working with an experienced retirement advisor can help set you up for success.
To learn how retirement planning can help ensure a smooth transition into and through retirement, watch for additional posts and planning tips in the weeks ahead, or contact us any time to discuss your planning needs.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply. Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion.
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