Making the right decision of when to turn on your social security benefit is critical. The wrong decision could cost you tens of thousands of dollars over the long run. Given all the variables surrounding this decision, what might be the right decision for one person may be the wrong decision for another. This article will cover some of the key factors to consider:
Normal Retirement Age
First, you have to determine your “Normal Retirement Age” (NRA). This is listed on your social security statement in the “Your Estimated Benefits” section. If you were born between 1955 – 1960, your NRA is between age 66 – 67. If you were born 1960 or later, your NRA is age 67. You can obtain a copy of your statement via the social security website.
Before Normal Retirement Age
You have the option to turn on social security prior to your normal retirement age. The earliest you can turn on social security is age 62. However, they reduce your social security benefit by approximately 7% per year for each year prior to your normal retirement age. See the chart below from USA Today which illustrates an individual with a normal retirement age of 66. If they turn on their social security benefit at age 62, they would only receive 75% of their full benefit. This reduction is a permanent reduction. It does not increase at a later date, outside of the small cost of living increases.
The big questions is: “If I start taking it age 62, at what age is the breakeven point?” Remember, if I turn on social security at 62 and my normal retirement age is 66, I have received 4 years of payments from social security. So at what age would I be kicking myself wishing that I had waited until normal retirement age to turn on my benefit. There are a few different ways to calculate this accounting for taxes, the rates of return on other retirement assets, inflations, etc. but in general it’s sometime between the ages of 78 and 82.
Since the breakeven point may be in your early 80’s, depending on your health, and the longevity in your family history, it may or may not make sense to turn on your benefit early. If we have a client that is in ok health but not great health and both of their parents passed way prior to age 85, then it may make sense to for them to turn on their social security benefit early. We also have clients that have pensions and turning on their social security benefit early makes the different between retiring now or have to work for 5+ more years. As long as the long-term projections work out ok, we may recommend that they turn on their social security benefit early so they can retire sooner.
Are You Still Working?
This is a critical question for anyone that is considering turning on their social security benefits early. Why? If you turn on your social security benefit prior to reaching normal retirement age, there is an “earned income” penalty if you earn over the threshold set by the IRS for that year. See the table listed below:
In 2016, for every $2 that you earned over the $15,720 threshold, your social security was reduced by $1. For example, let’s say I’m entitled to $1,000 per month ($12,000 per year) from social security at age 62 and in 2016 I had $25,000 in W2 income. That is $9,280 over the $15,720 threshold for 2016 so they would reduce my annual benefit by $4,640. Not only did I reduce my social security benefit permanently by taking my social security benefit prior to normal retirement age but now my $12,000 in annual social security payments they are going to reduce that by another $4,640 due to the earned income penalty. Ouch!!!
Once you reach your normal retirement age, this earned income penalty no longer applies and you can make as much as you want and they will not reduce your social security benefit.
Because of this, the general rule of thumb is if you are still working and your income is above the IRS earned income threshold for the year, you should hold off on turning on your social security benefits until you either reach your normal retirement age or your income drops below the threshold.
Should I Delay May Benefit Past Normal Retirement Age
As was illustrated in first table, if you delay your social security benefit past your normal retirement age, your benefit will increase by approximately 8% per year until you reach age 70. At age 70, your social security benefit is capped and you should elect to turn on your benefits.
So when does it make sense to wait? The most common situation is the one where you plan to continue working past your normal retirement age. It’s becoming more common that people are working until age 70. Not because they necessarily have too but because they want something to keep them busy and to keep their mind fresh. If you have enough income from employment to cover you expenses, in many cases, is does make sense to wait. Based on the current formula, your social security benefit will increase by 8% per year for each year you delay your benefit past normal retirement age. It’s almost like having an investment that is guaranteed to go up by 8% per year which does not exist.
Also, for high-income earners, a majority of their social security benefit will be taxable income. Why would you want to add more income to the picture during your highest tax years? It may very well make sense to delay the benefit and allow the social security benefit to increase.
The social security death benefit also comes into play as well when trying to determine which strategy is the right one for you. For a married couple, when their spouse passes away they do not continue to receive both benefits. Instead, when the first spouse passes away, the surviving spouse will receive the “higher of the two” social security benefits for the rest of their life. Here is an example:
Spouse 1 SS Benefit: $2,000
Spouse 2 SS Benefit: $1,000
If Spouse 1 passes away first, Spouse 2 would bump up to the $2,000 monthly benefit and their $1,000 monthly benefit would end. Now let’s switch that around, let’s say Spouse 2 passes away first, Spouse 1 will continue to receive their $2,000 per month and the $1,000 benefit will end.
If social security is a large percentage of the income picture for a married couple, losing one of the social security payments could be detrimental to the surviving spouse. Due to this situation, it may make sense to have the spouse with the higher benefit delay receiving social security past normal retirement to further increase their permanent monthly benefit which in turn increases the death benefit for the surviving spouse.
The “spousal benefit” can be a powerful filing strategy. If you are married, you have the option of turning on your benefit based on your earnings history or you are entitled to half of your spouse’s benefit, whichever benefit is higher. This situation is common when one spouse has a much higher income than the other spouse.
Here is an important note. To be eligible for the spousal benefit, you personally must have earned 40 social security “credits”. You receive 1 credit for each calendar quarter that you earn a specific amount. In 2016, the figure was $1,260. You can earn up to 4 credits each calendar year.
Another important note, under the new rules, you cannot elect your spousal benefit until your spouse has started receiving social security payments.
Here is where the timing of the social security benefits come into play. You can turn on your spousal benefit as early as 62 but similar to the benefit based on your own earnings history it will be reduce by approximately 7% per year for each year you start the benefit prior to normal retirement age. At your normal retirement age, you are entitled to receive your full spousal benefit.
What happens if you delay your spousal benefit past normal retirement age? Here is where the benefit calculation deviates from the norm. Typically when you delay benefits, you receive that 8% annual increase in the benefits up until age 70. The spousal benefit is based exclusively on the benefit amount due to your spouse at their normal retirement age. Even if your spouse delays their social security benefit past their normal retirement age, it does not increase the 50% spousal benefit.
Here is the strategy. If it’s determine that the spousal benefit will be elected as part of a married couple’s filing strategy, since delaying the start date of the benefits past normal retirement age will only increase the social security benefit for the higher income earning spouse and not the spousal benefit, in many cases, it does not make sense to delay the start date of the benefits past normal retirement age.
For divorced couples, if you were married for at least 10 years, you can still elect the spousal benefit even though you are no longer married. But you must wait until your ex-spouse begins receiving their benefits before you can elect the spousal benefit.
Also, if you were married for at least 10 years, you are also entitled to the death benefit as their ex-spouse. When your ex-spouse passes away, you can notify the social security office, elect the death benefit, and you will receive their full social security benefit amount for the rest of your life instead of just 50% of their benefit resulting from the “spousal benefit” calculation.
Whether or not your ex-spouse remarries has no impact on your ability to elect the spousal benefit or death benefit based on their earnings history.
Consult A Financial Planner
Given all of the variables in the mix and the importance of this decision, we strongly recommend that you consult with a Certified Financial Planner® before making your social security benefit elections. While the interaction with a fee-based CFP® may cost you a few hundred dollars, making the wrong decision regarding your social security benefits could cost you thousands of dollars over your lifetime. You can also download a Financial Planner Budget Worksheet to give you that extra help when sorting out your finances and monthly budgeting.
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.