Major changes are coming to Social Security retirement benefits, and now is the time to meet with clients and formulate a plan before a window of opportunity closes on April 30, 2016. Individuals turning age 66 before April 30, 2016 that have not filed for Social Security retirement benefits are the most exposed to the changes. It is also time for advisors to meet with all of their baby boomer clients to discuss the rule changes and their retirement plan timeline.
The Bipartisan Budget Act of 2015, signed into law Nov. 2, 2015, effectively eliminates two highly-discussed Social Security claiming strategies: file-and-suspend and file restricted. These two strategies have gained popularity with married couples as a way to increase lifetime Social Security income. File-and-suspend and file restricted strategies are an unintended consequence of The Senior Citizens Freedom to Work Act of 2000, which was designed to encourage more seniors to work. Now considered a “loophole,” the file-and-suspend caveat was originally intended to help senior citizens increase their Social Security benefit by delaying retirement.
The new law was passed with major changes to the tax code without any Congressional hearings, major discussion or debates on the floor of the House or Senate. The Center for Retirement Research at Boston College previously estimated the file restricted approach could add $9.5 billion in annual benefit costs to the program if everyone eligible pursued the strategy. The cost of the file-and-suspend tactic was estimated to have a more modest impact.
Advocates for rule changes argue that the ultra-wealthy are abusing the system to reap excessive rewards. In reality, removing the file-and-suspend and file restricted strategies will meaningfully reduce the overall Social Security benefits to millions of Americans across every income level.
(For more information, check out Kotlikoff: 10 Ways to Maximize Social Security Benefits Under New Law.)
The good news is there is time left to take action. Those who are already receiving benefits are not impacted at all, and clients who turn 66-years-old before April 30, 2016 can still file and suspend benefits, but they must do so by that date. Additionally, the file restricted strategy continues to be available to those who are age 62 or older on Dec. 31, 2015. Either strategy, or a combination of the two, can add tens of thousands of dollars in spousal benefits.
Advisors need to act fast to ensure their clients take the best course of action considering the new rules. First, it is important to fully understand the amendments. Because of their complexity, this can be a daunting task. The best way to go about tackling the complicated rules is to explain by using examples.
File-and-suspend, old rules
The idea behind file-and-suspend was to permit one spouse — usually the higher earning spouse — to file for retirement benefits at full retirement age, only to immediately suspend them. Once the benefits were suspended, the other spouse could then file for, and receive, spousal benefits. Remember, spousal benefits are not available until the primary worker files. The higher earning spouse then earns 8 percent delayed retirement credits until age 70, resulting in a 132 percent increase in monthly benefits.
Example: Jonathan is 65-years-old and still working. He plans to retire in the next year, but wants to let his Social Security benefits grow until age 70 to ensure the largest monthly and survivor benefit. His 61-year-old wife, Emily, has worked less than 10 years and does not qualify for her own retirement benefit.
Emily wants to start receiving her spousal benefit at age 62, even though her check would be reduced for claiming early. Jonathan plans to go online to the Social Security website at his full retirement age (FRA) and complete a file-and-suspend application in order for Emily to be able to file for a spousal benefit.
File-and-suspend, new rules
Under the new rules in Section 831 of the Bipartisan Budget Act of 2015, when the higher earner suspends his benefits, he will also suspend any benefits payable to his spouse or children.
Unfortunately for this couple, Jonathan is not FRA until after the April 30, 2016 file and suspend deadline. Therefore, Emily will not receive any benefits until Jonathan begins collecting his Social Security payments.
Additionally, there will no longer be an option to retroactively claim suspended benefits. Before the tax law change, a person who filed and suspended benefits could request a lump sum payment of the amount deferred. This caveat was also used by single individuals when the retiree became ill or had a change in financial circumstances. This option also goes away on April 30, 2016.
Deemed filing rule
The deemed filing rule is set to change as well. Under this rule, a spouse filing early before their full retirement age was deemed to be filing for their own retirement benefit first. It did not apply to those who filed for benefits after their full retirement age. This rule was considered the door-opener for couples’ strategies. This door has closed except for those who are 62 years old or older by the end of 2015. Under the new set of rules, deemed filing applies regardless of what age benefits are claimed. The person filing will receive the higher of their own benefit or the spousal benefit.