Does this cold, snowy winter have you thinking of quitting your job and retiring to Florida? I don’t blame you. But before you march in to your boss’s office tomorrow morning, let’s talk about managing what may be your biggest retirement asset: your Social Security benefits.
Social Security is one part of what is referred to as the “three legged stool” of retirement; the other two legs being your personal savings and employer provided pensions. As fewer employers offer pensions and those that do are freezing plans, that three legged stool is quickly becoming a two legged one- making it a difficult balancing act and even more important to manage your Social Security benefits to your advantage.
What is there to manage with Social Security? The timing of when to claim it for one, and if you are married, when your spouse should claim. At this point in time there are still several options available to maximize your benefit. In addition to maximizing your benefit, you will want to be aware of potential reductions in benefits as well as its taxation.
The first thing to know is that retirement and claiming Social Security are two separate issues. It is a common misunderstanding to think that when you retire you must notify Social Security and start claiming your benefits. Just as you can choose your retirement age, you can also choose your Social Security start date. Those dates may be one and the same, or, if you have other assets or income to draw from, can be years apart.
If you are fully insured for Social Security, you may start your benefits anywhere between the ages of 62 and 70. Fully insured means that you have accumulated 40 quarters of credits during your working years; in other words have been employed in a job that participates in Social Security for about ten years, assuming you earned four quarters of credits each year, a current quarter of coverage being $1,220 of earnings subject to Social Security tax. You cannot earn more than four quarters in a year, and the $1,220 does not have to be earned in each of the four calendar quarters. For instance working a job for one month during a year and earning at least $4,880 will give you four quarters even though you did not work in each of four calendar quarters. Earnings that are subject to Social Security tax are your gross wages less any pretax health insurance contributions, or your net self-employment income.
Your benefit amount is calculated based on your highest 35 years of earnings, indexed for wage increases. If you haven’t worked for a full 35 years, the years you were out of the workforce will count as zero and bring the average down. On the other end, earnings are only counted up to a capped amount that is determined annually, no matter how high they may be. For 2015 that cap is $118,500. Those 35 years of earnings are then converted to a monthly amount to come up with your “average indexed monthly earnings,” or AIME. That number then goes through a calculation to come up with your benefit amount, or “primary insurance amount,” PIA. One way to increase your benefit is to stay in the workforce long enough to replace lower or zero earning years with your current higher earnings. Those counted earnings can be problematic for self-employed individuals who work hard at reducing income for tax time; it may be beneficial for the short term to pay lower income taxes, but in the long run reduces your retirement benefit.
When it comes time to collect, age matters; your benefit amount will vary with your age at that time. The full retirement age (FRA) is between 65 and 67, depending on your year of birth. FRA is age 66 for those born between 1943 and 1954, between 66 and 67 for those born between 1955 and 1959, and 67 for all those born in 1960 and later. If you claim Social Security at your FRA, you will receive 100 percent of your benefit amount.
Claiming early results in an actuarially reduced amount; a 62-year-old today would only receive 75 percent of his or her PIA. As full retirement ages rise, that cut is even bigger; for someone who is 50 years old now, claiming at age 62 is a 30% reduction. If that person waits until age 70 instead, the benefit amount increase is 8% per year of the PIA. So today’s 62 year old would see the benefit increase by 32% over claiming at 66; and today’s 50 year old would see the benefit rise by 28% over claiming at full retirement age of 67. In real numbers, if our 62 year old had a primary insurance amount of $1,000 a month, he would receive $750 claiming now at 62, or could be as much as $1,320 at age 70. That significant difference is meant to make up for the fact that the recipient will receive fewer checks over the course of his or her lifetime.
For many potential retirees, circumstances are such that claiming at age 62 is a financial necessity, regardless of the cut in benefits. In fact, they may need to continue working to make ends meet. But what happens to your benefit then? Does the government take back so much that it’s not worth working?
If you claim prior to your full retirement age and continue to work earning more than the 2015 limit of $15,720 per year, your Social Security check will be reduced by $1 for every $2 you earn in excess of that. But the money is not truly lost. At your full retirement age Social Security will recalculate and permanently increase your benefit amount to account for the months that you had benefits withheld. If it turns out that a year in which you are both working and receiving benefits is one of your high 35 years of earnings, then Social Security will add that year in and recalculate your benefit as well.
In the year in which you attain full retirement age, the earnings limit is higher, at $41,880. That earnings limit only counts for the months prior to your attaining full retirement age, and your benefits are reduced $1 or every $3 over the limit. Beginning in the first full year after reaching full retirement age you may earn as much as you like without any reduction in benefit.
If you expect to earn over the limit in any year prior to your full retirement agent, you need to notify Social Security (800-772-1213 or your local office) so your benefits can be reduced accordingly. If you do not notify them, you will be required to repay the benefit. It’s best to work with Social Security and keep them abreast of changes in your income to avoid any surprise bills or unnecessary reductions in the event your income goes down. You can calculate how working affects your benefits on the Social Security website at http://www.ssa.gov/OACT/COLA/RTeffect.html.
Is it worth it to wait to claim Social Security, or is it best to get your money as soon as possible?
The answer to that question is complex, and unique to each person or couple’s life situation. Next time we’ll explore the pros and cons of various claiming options and strategies, as well as how your Social Security is taxed.