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Ultimate Guide to Social Security Benefits

This is going to be heresy for most financial advisors: you’re better off taking Social Security early. You shouldn’t wait.


This isn’t a hard and fast rule though. Claiming early is more of a guideline.


In previous years, claiming strategies like File & Suspend made it advantageous to wait as long as possible before beginning payments. That’s not the case now. The rules were changed in 2015 and the loopholes were eliminated, which has made the timing question much simpler.


You’ll hear that your Social Security payment grows every year that you wait…and that’s true. It grows at 7-8% per year, every year until you turn 70. That’s the good news. The bad news is that if you wait until you’re 70 to begin payments, you have to live another 11 years before you actually draw more, in total, than you would have had you begun payments at 62. You’re betting that you will live longer than the IRS expects.


The average 70-year-old American man will live till 85, the average American woman will live to nearly 88.  With advances in longevity, the odds are on your side. The problem is that some dollars are worth more than others.


You’re probably thinking but Jeb, Social Security is indexed for inflation.


Yep, it is. I’ll explain Cost of Living Allowances below, but that’s not what I mean here.

I’m speaking of the fact we all slow down as we age. A dollar in your 60’s is worth more because you have more options for spending it. Studies, and my own anecdotal experience, show that spending decreases throughout retirement, but even more quickly in your 80’s.


Fun spending decreases, supplanted by increased spending on medical expenses and taxes.


On the other hand, I know many 60-year-olds who still play golf 4-5 times a week. An extra check at 62 or 65 might mean extra trips with the grandkids or more spending on fun stuff.


This is one of the areas where there’s a mathematical answer and there’s a real-life answer. The mathematical strategy for getting the absolute highest amount of dollars from Social Security is to wait till 70 to begin claiming. The real-life answer is that a dollar today is worth two tomorrow.


That said, there are a few places where you can still use claiming strategies to make a difference, particularly if you’re planning on working part-time prior to your Full Retirement Age or if you’re either a widow / widower or divorced. I’ll explain the options and strategies for these situations below.


 

How Social Security ‘Works’

Before we get to the special situations, I want to give some background on the mechanics of Social Security. I’m not going into the weeds to discuss its Great Depression era origin, but you should have an idea of what qualifies someone for Social Security, how Social Security payments are calculated, and how you actually apply for payments.


Eligibility

First, to qualify for Social Security retirement benefits, you need to have earned at least 40 "credits" during your working years. In 2021, for example, you earn one credit for each $1,470 in earnings, up to a maximum of four credits per year. Ten qualifying years, forty credits, mean that you’re eligible for benefits. I should clarify that I’m only talking about Social Security retirement today. There are other Social Security programs, like SSDI and SSI, but I’m only discussing the retirement portion.


How Social Security Benefits are Calculated

Social Security benefits are calculated based on your lifetime earnings, adjusted for inflation. Specifically, the Social Security Administration calculates your Average Indexed Monthly Earnings (AIME) by taking your 35 highest-earning years (in terms of wages that were subject to Social Security taxes) and averaging them out. The AIME is then used in a formula that applies a progressive benefit structure, meaning lower-earning years are weighted more heavily than higher-earning years. The result is the Primary Insurance Amount (PIA), which is the basis for the benefits that will be paid out.


There is also a maximum limit on the Social Security benefits one can receive, which is adjusted annually for inflation. As of 2021, the maximum monthly Social Security benefit for a worker retiring at full retirement age is $3,148. This maximum amount is only attainable for individuals who have consistently earned the maximum taxable income or more throughout their 35 highest-earning years. The maximum taxable income for Social Security purposes was $142,800 in 2021, meaning earnings above this amount in any given year are not subject to Social Security taxes and do not factor into benefit calculations.


Full Retirement Age

Your Full Retirement Age (FRA) is the age at which you can claim 100% of your PIA. FRA varies depending on your birth year; for those born in 1960 or later, the FRA is 67. Claiming benefits before reaching FRA will result in a permanently reduced monthly benefit, while delaying benefits past FRA can increase your monthly payments.


You can begin collecting Social Security payments at age 62. If you wait, your benefit will continue growing until you turn 70, at which point the benefit stays the same. The benefit will grow by approximately 7-8% per year, for each of those years.


Cost of Living Adjustments

To help keep up with inflation, Social Security benefits are subject to annual Cost-of-Living Adjustments (COLA). The percentage increase is determined by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). In 2023, the COLA was 8.7%, as inflation ran rampant for most of 2022.


Spousal Benefits

Spousal Social Security benefits are to provide support to a spouse who either has a lower income or has not worked outside the home. If you are married, you may be eligible to receive Social Security benefits of 50% of your spouse's full retirement benefit amount or your own, whichever is higher. Claiming spousal benefits does not reduce the amount your spouse receives either. You can claim spousal benefits as early as age 62, but doing so before reaching your full retirement age will result in a reduced benefit.


WEP and GPO

The Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO) are two provisions in U.S. Social Security law that may reduce Social Security benefits for individuals who also receive pensions from employment not covered by Social Security. These provisions are designed to adjust benefits for people who have government or foreign pensions and may not have contributed sufficiently to the Social Security system.


The Windfall Elimination Provision primarily affects individuals who have earned a pension from an employer that did not withhold Social Security taxes and who also worked in other jobs long enough to qualify for Social Security retirement or disability benefits. Here in Kentucky, this typically affects teachers. WEP alters the formula used to calculate these individuals' Social Security benefits, generally resulting in a lower monthly benefit amount. The reduction is calculated based on a modified formula and is subject to a maximum limit. It's important to note that WEP does not eliminate Social Security benefits entirely, but it can significantly reduce them. It can also keep you from receiving spousal benefits after your spouse passes away. My Mom doesn’t receive survivor benefits from Dad, even though he was eligible for benefits when he passed away, because she’s a retired Kentucky teacher and as I mentioned, Kentucky teachers don’t pay into Social Security.


The Government Pension Offset, on the other hand, affects Social Security spousal or survivor benefits. If you receive a pension from a federal, state, or local government based on work where you did not pay Social Security taxes, your Social Security spousal or survivor benefits may be reduced. The GPO reduction is equal to two-thirds of the amount of your government pension. In some cases, this can result in your spousal or survivor benefits being completely offset, meaning you would receive no Social Security benefit based on your spouse's earnings record.


 

Understanding YOUR Social Security Benefits

You can find your benefits in two places. First, the Social Security Administration mails out a copy of your Social Security statement three months prior to your birthday each year you turn 60. The other option is to sign up for an account at SSA.gov and view your statement there.


Here are the important parts from the paper statement.



Social Security benefits tool


This shows your estimated monthly benefit at various retirement ages.



Social Security benefits tool


The important items here are that you are qualified for retirement benefits, as you have more than 40 credits. Also, it shows your full retirement age.



Social Security benefits tool

Finally, this is your earnings record. As I mentioned earlier, you want to always double check that these numbers are correct. If they’re not, you’ll need to update them by bringing a copy of your tax returns to the SSA.


Online Access

I recommend getting the SSA.gov account. The paper statement is great for your records, but having access to the SSA site will give you more options and information.


Start by going here. You’ll go through the enrollment process, which takes less than ten minutes, and then you’ll have access to your my Social Security Account. From here you can confirm you have enough work credits to be eligible, your Social Security earnings for each year, and you can also see an estimate of your retirement benefits. Be sure to check your eligible earnings for each year; incorrect earnings can cost you when you’re ready to retire.



Social Security benefits tool


 Social Security also has a benefits calculator in the Plan for Retirement tool, which is neat. You can use it to see the difference between payments at each age, which is particularly helpful if you’re near retirement and don’t expect a significant change in average salary prior to retirement. You can also use it to see the difference that your average salary will have on your future Social Security benefit. The longer you have till retirement, the more of a difference a change in salary will make. Finally, you can use it to compare your benefit with your spousal benefit. If you know your spouse’s numbers, you can compare them to your own at each claiming age.


How to Apply for Social Security Benefits

Applying for Social Security benefits can be done in several ways, including in-person at a Social Security office or online through the Social Security Administration's (SSA) website. I recommend applying through the website unless you have a particularly complicated application.  


Here's how to go about each method:


In-Person Application:


  1. Schedule an Appointment: The first step is to schedule an appointment with your local Social Security office. You can find the nearest office by using the SSA's office locator tool on their website or by calling 1-800-772-1213.

  2. Gather Required Documents: Before your appointment, gather all the necessary documents. This usually includes proof of U.S. citizenship or lawful alien status, a copy of your U.S. military service paper(s) if you had military service before 1968, and copies of your W-2 forms or self-employment tax returns for the last year. If you’re claiming based on your spouse’s record, you’ll need to bring your marriage certificate. If claiming on an ex-spouse (I’ll cover this shortly), you’ll need both your marriage certificate and divorce decree.

  3. Attend the Appointment: Go to the Social Security office at the scheduled time and meet with a representative. They will guide you through the application process, review your documents, and answer any questions you may have.

  4. Submit the Application: Once everything is in order, you'll submit your application. You may be asked to provide additional documentation or clarification, so make sure to comply promptly to avoid delays.


Online Application:


  1. Visit the SSA Website: Go to the Social Security Administration's website and navigate to the "Online Services" section.

  2. Create or Log In to Your Account: If you don't already have a 'my Social Security' account, you'll need to create one. If you already have one, simply log in.

  3. Start the Application: Once logged in, you can start a new application for Social Security benefits. The online application will guide you through a series of questions about your work history, marital status, and other relevant information.

  4. Submit Documents: You may be required to submit additional documents, such as proof of identity or income records. These can often be uploaded directly through the online portal.

  5. Review and Submit: Before submitting, you'll have a chance to review your answers and make any necessary changes. Once you're satisfied, submit the application.


 

After applying through either method, you'll receive a confirmation and be able to track the status of your application online. The SSA may contact you if they need further information or documentation. Once your application is processed, you'll receive a notice about your eligibility and, if approved, information about your benefit amount and start date.


Social Security Taxes

Up to 85% of Social Security benefits may be taxable, depending on your overall income. Generally, if Social Security is your only source of income, your benefits probably aren’t taxable. However, if your combined income is more than $25,000, your Social Security will be taxable. To determine the taxable amount, you'll need to calculate your combined income, which is the sum of your adjusted gross income, nontaxable interest, and half of your Social Security benefits.


If you find that your benefits are subject to taxation, you have federal taxes withheld from your Social Security payments. To set up or change your tax withholding, you can fill out Form W-4V (Voluntary Withholding Request) and submit it to the Social Security Administration. This form allows you to choose the percentage of your monthly benefit amount you'd like withheld for taxes—options are 7%, 10%, 12%, or 22%. Even simpler, you can also make changes to your withholding settings through your 'my Social Security'

account online.


Special Scenarios – Working in Retirement

If you want to work part-time in retirement, you need to be careful about when you begin taking Social Security. Earned Income Limits come into play at relatively low income levels, so be aware of your income. Exceeding these limits can temporarily reduce your monthly Social Security payments. The income limits vary depending on your age and whether you've reached your full retirement age.


For those below full retirement age, the limit for 2021 was $18,960 per year; if you earned more than this, your Social Security benefits would be reduced by $1 for every $2 earned over the limit. The year you reach your full retirement age, the limit increases, and the reduction rate changes to $1 for every $3 earned over the limit until the month you reach full retirement age. After reaching full retirement age, there are no earned income limits, and you can earn as much as you like without affecting your Social Security benefits.


It's worth noting that only earned income—wages from job or net earnings from self-employment—are counted towards these limits; other types of income like pensions, withdrawals from retirement accounts, and capital gains do not impact your Social Security benefits.


Special Scenarios – Widow / Widower

For a 60-year-old widow, certain unique claiming options are available. Widows are eligible to start claiming survivor benefits as early as age 60, but doing so will result in a permanently reduced benefit—about 71.5% to 99% of the deceased spouse's benefit amount, depending on the age at which you claim. If you wait until your full retirement age, you can receive 100% of your deceased spouse's benefit.


What often makes sense, depending on work history, is for a widow to claim the reduced survivor benefits at age 60 and then switch to their own retirement benefits at full retirement age or later if those benefits are higher. This strategy allows for early cash flow, while allowing the other benefit to continue growing.


Special Scenarios – Divorced

Divorced individuals may also be eligible for Social Security benefits based on their ex-spouse's earnings record, provided certain conditions are met. To qualify, the marriage must have lasted at least 10 years, and the individual claiming the divorced spouse benefit must be currently unmarried and at least 62 years old. The ex-spouse must also be eligible for Social Security benefits, although they do not need to have started claiming them yet. If these conditions are met, a divorced spouse can claim up to 50% of the ex-spouse's full retirement benefit amount.


One common strategy is to claim divorced spouse benefits while delaying one's own retirement benefits. This allows your own benefits to grow due to delayed retirement credits, which can increase your monthly payment by a certain percentage for each year you delay claiming beyond your full retirement age, up to age 70. At that point, you can switch from the divorced spouse benefit to your own, higher benefit.


If you've been divorced more than once and each marriage lasted at least 10 years, you have the option to choose which ex-spouse's record will provide the higher benefit. However, you can't claim benefits on multiple ex-spouses simultaneously. That would just be too much.


It's also worth noting that claiming divorced spouse benefits does not affect the benefit amount your ex-spouse or their current spouse may receive. You aren’t pulling one over on your ex by claiming on their record.


Big Picture

I’ll keep it short, after writing 3,000 words on the subject. Unless you’re in one of the special scenarios above, you’re likely better off taking your Social Security benefits as soon as you’re able, without penalty. You don’t have to overthink this, as the difference between the different options are rarely significantly different. In most clients I’ve worked with, the total difference in lifetime payouts isn’t terribly big. We’re talking $30,000-$50,000, but over the course of fifteen to twenty years. When you break it down to a yearly or monthly difference, I find that most retirees are happier having the money in their pocket earlier.


- Jeb


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