Looming changes to the Social Security system meant to shore up its pending insolvency have created a renewed sense of urgency for maximizing Social Security benefits for high net worth clients. Because these clients are often financially secure enough to delay their Social Security benefits past the normal retirement age, when they can reap a higher benefit level, they have become the likely target of the impending Social Security reform. There is a strong possibility that the powerful file and suspend strategy for maximizing Social Security benefits will not survive the transition, so it is time to engage your retirement-aged clients in a Social Security planning discussion before it is too late.
The “file and suspend” strategy
Because it is in the government’s interest to encourage workers to delay collecting Social Security benefits, your clients who wait past the normal retirement age to begin collecting are rewarded with an increase in benefits for each year benefits are delayed. This results in a higher benefit being paid to the client, but in some cases, the government comes out ahead when the client does not live long enough to begin collecting benefits.
In some instances, if your client has reached full retirement age but wishes to delay collecting benefits in order to reap the higher benefit level in later years, the client can take advantage of a strategy known as “file and suspend.” This strategy allows a spouse to begin collecting spousal benefits without jeopardizing the amount of the working spouse’s retirement benefit. The working spouse simply files for benefits and then makes a subsequent filing to suspend these benefits.
During the time that the benefits are suspended, the working client earns delayed retirement credits, which increase the eventual benefit level by 8 percent for each year in which benefits are suspended. The taxpayer must begin to collect benefits by age seventy, by which point the benefit level can be increased substantially.
A working spouse may collect spousal benefits but can similarly suspend any work-related benefit, so that it too can continue to grow until the working spouse reaches age seventy. At that point, both spouses would be entitled to a larger benefit and would still have collected some Social Security income in the intervening years.
The file and suspend strategy removes some of the upside potential that the government can realize through encouraging workers to delay collecting benefits—namely, the possibility that those benefits will never be collected, thus increasing the Social Security fund level. As a result, proposals for reforming Social Security have focused on eliminating the file and suspend strategy.
Other reform proposals
The administration’s proposals also include modifying the cost of living adjustments that are applied to increase Social Security benefits each year. By switching to some form of the chained CPI method, the benefits paid out under Social Security would increase at a slower rate, thus helping to extend the life of the current retirement fund.
Further, several proposals seek to either remove or increase the earnings limit that caps the amount of a worker’s compensation that is subject to the Social Security tax. While plans to modify the earnings cap have been proposed unsuccessfully in the past, the imminence of the Social Security funds’ exhaustion may influence opponents to agree to these measures.
The death of Social Security has been discussed for years without any significant action being taken to solve the problems inherent to the system. Today, because the ability to push the solution to some point in the future is no longer a viable option, reform has become inevitable.
For previous coverage of strategies for maximizing Social Security in Advisor’s Journal, see Navigating the Maze: Social Security, Spouses, and Survivors.