Social Security is a valuable retirement asset. With a lifetime guarantee, government backing and an 8 percent rate of return for delayed collection, it’s an excellent adjunct to any portfolio.
Yet many retirees don’t know how to make the most of their benefits. According to the Nationwide Retirement Institute, 86 percent of future retirees don’t know what factors determine the maximum amounts they can receive, and roughly one-quarter of current retirees overestimated their benefits.
At the same time, over two-thirds of retirees report their expenses have stayed the same or increased. Among those who report a lower quality of life in retirement, the top reasons are:
- Cost of living
Health care expenses in particular keep 1 in four retirees from living the lives they expected, and most couples see medical costs consume two-thirds of their Social Security checks.
Sounder Social Security strategies can make retirement more affordable, but consumers need help to get there. Most aren’t receiving Social Security advice from their advisors, and the majority of those who do have had to initiate the discussion themselves. Overall, the current situation presents a perfect opportunity to advisors who want to gain new business and add value for current clients.
In part one of this series, we discussed the impacts of collection age and the reasons why today’s retirees probably don’t need to fear the end of Social Security. In this installment, we’ll cover specifics: how to estimate a client’s benefits, make the most of SSI and incorporate it into a tax-efficient income plan.
Determining clients’ benefits
The maximum Social Security benefit for someone turning 66 in 2017 is $2,687 per month; the average benefit overall is $1,342.
How can your clients figure out where they’re going to fall?
The Social Security Administration looks at your best 35 years of earning, and other years’ zeros don’t matter,” says Beth Blecker, CEO of Eastern Planning.
More specifically, the SSA looks at the 35 highest-earning years in today’s dollars. Those earnings are divided by 420 (35 years x 12 months) to arrive at the Average Indexed Monthly Earnings (AIME). To determine the primary insurance amount, the AIME is run through a benefits formula with different multipliers, similar to the application of income tax brackets. Maximum countable earnings are the same as the payroll tax limit – $127,000 in 2017.
The SSA offers a retirement estimator to simplify consumer calculations, but clients must understand the basics. Part-time work and time off can drastically lower AIME, but just a few years of full-time work can bring it back up. If you have a client on the fence about early retirement, a better picture of their earnings history may encourage them to keep working for a few more years.
Business owning clients should also take note: It pays to take a salary.
“A lot of business owners try to keep their salaries as low as possible, but that’s part of the reason why they tend to hate Social Security,” says Blecker. “Pay yourself so you’re actually putting money into the program.”
Minimizing taxable income is the go-to strategy for many small-business owners, but for most self-employed clients, it’s a safer bet to mark down at least a modest taxable income.
“If you’re filing and married, it’s not a ‘me’ decision, it’s a ‘we’ decision,” says Franklin Templeton financial planning spokesperson Gail Buckner. Maximizing a couple’s retirement income requires a coordinated claiming strategy – especially when one spouse has significantly out-earned the other.
As important as spousal benefits are, plenty of consumers are still in the dark.
“The whole topic is poorly understood,” says Hans Scheil, CEO of Cardinal Retirement Planning. “All spouses are eligible at the full retirement age to apply for half of their spouse’s retirement benefits.”
Spouses can even apply as early as 62 ½ – but only if the main beneficiary has also claimed early. Early collection is even less advisable for couples, though, since it reduces the spousal benefit by 30 percent. For a same-age couple, that means a lower-earning 62-year-old would get just over one-quarter of the main breadwinner’s benefit.
Still, there is a way for couples to collect two checks while maturing the higher earner’s benefit – at least for now. As long as the higher earner was born before 1954 and has reached full retirement age, they can file a restricted application to collect half of the lower earner’s benefit. Once they reach 70, they can switch gears and collect 132 percent of their own benefit.
Widows and widowers also get benefits, but the details are different.
“Lots of people are confused about the survivor benefit in particular” says Doug Amis, CFP with Cardinal Retirement Planning. “People think they’re going to get a lump sum when their spouse dies.”
The survivor benefit actually entitles a beneficiary to 100 percent of the deceased worker’s benefit, doled out in lifetime monthly payments as before. The survivor is also stuck with the deceased spouse’s filing decision, so married breadwinners with low life expectancies should still think twice about collecting early.
Taxation and income timing
What many retirees don’t realize – at least until they receive their first check – is that Social Security income is indeed subject to federal income tax. For single filers, 50 percent of SSI is taxable for combined incomes between $25,000 and $34,000; 85 percent for incomes over $34,000. The same percentages apply to joint filers between $32,000 and $44,000 and above $44,000, respectively.
These figures are critical to constructing a well-timed, tax-efficient income plan.
“Don’t be opposed to drawing down your 401(k) and other assets since you’ll have to draw them eventually at 70, anyway,” says Buckner. “The 8 percent increase in your Social Security benefits, guaranteed from 66 to 70, is pretty hard to replicate with any other investment.”
Ultimately, by drawing down retirement accounts and delaying Social Security, clients can reduce their minimum distributions – and tax brackets – while growing their less-taxable SSI.
Education, outreach and long-term planning
As valuable an asset as Social Security can be, high-earning retirees tend to downplay its importance.
“Lower earners make it too big a part of their plan, but higher earners look down on it,” says Blecker. “I don’t care how much extra you have coming in, it’s a big part of retirement, and an extra $1,5000 or $2,000 per month is significant.”
Given Social Security’s unique tax status and growth potential, the right collection age, spousal coordination and drawdown strategies can provide a significant boost to just about any couple’s retirement income.
Given the dearth of in-depth, personalized Social Security advice, forward-thinking advisors have an excellent opportunity to grow their practices and position themselves as trusted experts on this critical, controversial topic. Simple software can spit out collection dates, but clients need more.
“You need to have the working knowledge to play through hypothetical scenarios – how strategies really affect spouses, children and the overall income plan,” says Amis. “When clients come to us from other advisors, they usually haven’t had those conversations.”