How great a role should Social Security play in your clients’ retirement income plans? And just as importantly, how should its collection be coordinated with retirement account distributions and other income streams?
Nationwide Retirement Institute research shows that recent and future retirees expect the program to provide 57 percent of their income. And considering that the average annual payout is just under $17,000, that may be a decent estimate for a married couple with shared expenses and a paid-off home.
For many seniors, however, that estimate is just a guess. Most recent and soon-to-be retirees haven’t received any Social Security help from their advisors, and among those who did receive advice, over half had to initiate the discussion themselves. What’s more, 45 percent of future retirees don’t understand what expenses will be withheld from their benefits, and at least half don’t understand how their monthly benefits are determined.
Clearly, these clients can use your help.
“Lower and middle-income people tend to use Social Security as a crutch, while those with higher net worth don’t think about the total benefits they can receive,” says Carrie Turcotte, Partner and Wealth Management Advisor at Wells Fargo Advisors.
As a significant guaranteed income stream, properly timed Social Security distributions can help your clients cover their costs and make the most of other assets and income streams. By properly placing it within their broader retirement pictures, you can provide lasting peace of mind while helping them to achieve their retirement goals.
Expenses in retirement
According to the Social Security Administration, 48 percent of married couples receive at least half of their income from Social Security, with 21 percent relying on the program for 90 percent or more. The SSA also recommends that benefits replace about 40 percent of income for average earners (more for low earners and less for high-income families).
For most clients, however, an honest look at expenses is more important than any statistic or rule of thumb – an essential starting point for allocating Social Security and determining a realistic standard of living.
“You’ll often hear that you can live on 70 to 80 percent of your previous income when you retire, but it really depends on your situation,” says Barry S. Waronker, JD, Senior Partner and CEO of Informed Family Financial Services.
Specifics vary from one family to the next, but clients can rest easy if they understand a couple of key points. First, they’ll have a great deal of cash freed up now that they’re no longer saving. Second, the first few years of retirement won’t be indicative of their long-term income needs.
“There are go-go, slow-go and no-go years,” says Waronker. “Oftentimes, people need to build up more income up front, but as they get into their 70s and 80s, they slow way down on spending.”
Instead of considering Social Security in proportion to a client’s overall portfolio, it makes more sense to separate it completely, treating it as the safety net it was designed to be.
“Social Security and other safe sources should be the base of your income – especially given the unpredictability of the stock market,” says Waronker. “That lets you feel safe and have a consistent paycheck, with money left over for vacations, gifts and other extras.”
With the average retirement costing around $750,000 and lasting just under 20 years, Social Security may cover the bare bones for middle-class clients. But wealthier retirees with higher standards of living will likely need additional income from pensions, lifetime annuities and other guaranteed sources.
There’s another benefit to treating Social Security as an income stream, rather than an asset: “It can make people less aggressive or less reliant on equity returns to meet their needs,” says Ben Westerman, Senior Vice President of HM Capital Management. With their needs met through guaranteed income, clients can allocate their riskier investments to luxuries, inheritances and longer-term goals that can better withstand market corrections.
Timing and tax reductions
Given its unique tax status and growth opportunities, Social Security is also an excellent tool for minimizing tax liabilities and making the most of other income sources. Benefits grow 8 percent per year after full retirement age, and unlike 401(k) and IRA distributions, their taxation tops out at 85 percent.
“There’s usually a sizeable gap between when our clients retire and when they start taking Social Security because we almost always push it to 70,” says Westerman. “Pull money out of retirement accounts in those first four to five years, and you’ll pay very little in the way of taxes.” For retirees with income to spare in their 60s, Roth conversions provide for even more tax-qualified income later on.
On the other hand, drawing early to preserve retirement accounts – the route many seniors still stake – is doubly inefficient. Instead of drawing down finite assets now to enjoy greater lifetime income later, they’ll permanently reduce their benefits and face significant tax liabilities when the RMD kicks in at 70 ½.
Planning for shortfalls
Social Security may cover a client’s costs today’s, but the future is full of potential shortfalls. Inflation is one of the most prominent, and while the cost of living adjustment was designed to account for rising costs, it hasn’t kept pace with the prices that impact seniors the most.
“At most, a 1.5 percent COLA should be used in clients’ plans, and it might be fair to rule it out entirely,” says Turcotte.
Medicare is another wild card that could offset what beneficiaries do get from the COLA. Part B premiums have steadily risen to the current all-time high of $134, and by law, the dollar amount of the increase can be as much as the dollar amount of the COLA. Even if the COLA rises back above its historic lows, inflated health care costs could prevent beneficiaries from reaping any real benefit.
Finally, the death of a spouse can significantly disrupt a couple’s income plans, particularly when that spouse was the main breadwinner – and even more so if that breadwinner collected early. The survivor is entitled to their spouse’s full benefit, but considering housing and transportation costs, the decrease in expenses may not match the reduction in total household Social Security income.
“You need to somewhat coldly consider the next 20 to 30 years,” says Waronker. “Do you want an 80-year-old survivor to be short-changed because the breadwinner decided to collect at 62 ½ and not worry about the future?”
These shortfalls aren’t necessarily cause for alarm, but they should prompt clients to plan their collections and allocations accordingly. Conservative planners might weigh their present-day Social Security benefits against their inflation-adjusted expenses 15 to 20 years out, making up the difference with other guaranteed sources of income.
Avoiding the investment trap
For the vast majority of clients, delayed collection is a must for making the most of Social Security. But some seniors view Social Security as an asset rather than an income stream, weighing its “present value” against other parts of their portfolios. In some cases, this view motivates seniors to collect early in the attempt to invest and reap an even greater return.
“Stuff like that tends to not work out nearly as well as people think it’s going to,” says Westerman. “One of the biggest benefits of delaying is reducing your risk, and God forbid you spend down all your other assets, you’re still getting the most you can from Social Security.” Plus, it’s tough to beat Social Security’s 8 percent guaranteed rate of return, particularly in a low interest environment that requires a not-so-senior-friendly stock allocation.
Helping your clients appropriately place Social Security income into their retirement plans will lead them toward sound decisions as they save, file for benefits and allocate other assets and income streams.
“It’s a value add, and even if clients aren’t paying directly for it, it’s another way they can rely on you,” says Westerman. “If you’re not doing it, you’re at a big risk of clients leaving you for an advisor who will.”
Fortunately, clients are eager to listen. Nationwide research shows that among seniors who receive Social Security advice, almost all took it into consideration, and roughly one-third followed it to the letter. If you can offer sound Social Security strategies – and provide reasoning – you’ll only strengthen your position as a trusted advisor.