Deciding When to Start Receiving Social Security Benefits

Background

Workers are generally entitled to begin taking monthly Social Security retirement benefits once they reach age 62. However, the full benefit will be permanently reduced for each month the benefits are received before the individual’s full retirement age. On the other hand, benefits increase if the individual delays receiving benefits until after full retirement age. Thus, a taxpayer approaching age 62 needs to decide whether to begin taking reduced Social Security benefits or wait until full retirement age (or later).

A worker’s full retirement age varies depending on the worker’s birth date. The full retirement age is 66 for workers born after 1942 and before 1955, it’s age 67 for those born after 1959, and it’s somewhere between age 66 and age 67 for those born after 1954 and before 1960.

Social Security benefits are calculated by reference to the Primary Insurance Amount (PIA), whether the worker is fully insured, and a number of other factors. The calculation is complicated and many of the factors change each year. Fortunately, the Social Security Administration has an online calculator (called the Retirement Estimator) on its website (www.ssa.gov) that provides an estimate based on the individual’s actual Social Security earnings record.

Depending on the worker’s life expectancy and tax bracket, the present value of the Social Security retirement benefits received will usually be similar regardless of when benefits begin. Therefore, this decision will often depend on factors other than trying to receive the greatest lifetime benefit from Social Security. Some workers will delay retirement and continue to work because of personal preference. Others will need to take early Social Security benefits because they are unemployed, underemployed, or have an immediate financial need. Those in a better financial situation often have the luxury to wait and allow their benefits to increase, thus ensuring a more comfortable retirement.

Factors to Consider in Taking Reduced Benefits at Age 62

For 2012, the benefits at age 62 are reduced by 25% of what they would be at age 66 (i.e., the full retirement age), but the worker will receive more Social Security checks if benefits are drawn early. In addition, drawing early Social Security benefits may allow the worker to leave tax-deferred retirement accounts untouched and growing for longer periods.

    Example 1: Curt is single and plans to retire on his 62nd birthday in 2012 when his PIA is $2,000. If he starts benefits at age 62, he will receive monthly payments of 75% of his PIA, or $1,500. Thus, he will have received 48 benefit checks of $1,500 each, a total of $72,000, when he reaches age 66 (his full retirement age). His benefit would be $2,000 if he waited until age 66 to start benefits, so it would take more than 11 years before the increased $500 per month ($2,000 – $1,500) equaled the $72,000 he would have received between ages 62 and 66. Therefore, Curt would receive 15 years of benefits beginning at age 62 ($1,500 x 180 months = $270,000) before he would receive the same amount of total benefits if payments had started at age 66 ($2,000 x 135 months = $270,000).

Bottom Line: If the worker waits until the full retirement age to draw benefits (and the PIA remains the same), it will take around 11 years to reach the break-even point to make up for the years of payments that were not received. Therefore, if the worker does not expect to live until age 77, more benefits will be received by taking the reduced monthly payment.

If the present value of future Social Security benefits is considered, it would normally be more favorable to start the benefits as soon as possible. However, if the early Social Security benefits replace a similar amount of earned income, the short-term position will not be improved and the long-term outlook will suffer.

Factors to Consider in Waiting until Full Retirement Age

Those who reach age 62 and desperately need retirement income may have to take early benefits. And those with a shorter life expectancy might be wise to take early benefits because they may not receive them for very long. Other retirees should carefully consider the long-lasting advantages of waiting until their full retirement age. Factors to consider include:

  • Life Expectancy. The worker’s life expectancy may be the biggest factor in deciding whether to start benefits early. Tables and averages are available. However, the worker’s current health and the longevity of parents should also be factored in. In general, 80 years might be a good cutoff point. If the taxpayer reasonably expects to reach that age, waiting until the full retirement age may be a wise choice.
  • Shortening the Retirement Period. A significant factor in retirement planning projections is the length of the retirement period. For example, if a worker wants to retire at age 62 and has a life expectancy of 85, there is a 23-year retirement period to fund. By working past age 62, the worker is shortening the retirement period and decreasing the resources needed to fund the retirement regardless of longevity.
  • Replacing Lower-wage Years .An individual’s Social Security benefits are based on his or her PIA. The PIA is calculated from the individual’s highest earnings during a 35-year calculation period. If a taxpayer can replace lower-wage years with higher-wage years after age 62, the PIA can be increased. This can lead to a dramatically higher retirement benefit when the individual retires.
  • Inflation Adjustments. Social Security benefits receive an annual inflation adjustment. By taking early benefits, the individual will receive a smaller annual increase and miss out on the compounding effect of that increase. For example, an individual with a PIA of $2,000, who begins benefits at age 62, will receive only $1,500 per month and will miss out on the compounded inflation adjustment of that $500 in lost benefits. In other words, the gap between the early retirement benefit and the amount he or she would have received by waiting will get bigger and bigger.
  • The Effect on the Spouse. Starting benefits early may also affect a spouse’s benefits. At full retirement age a worker’s spouse is eligible for spousal benefits of 50% of the working spouse’s PIA. So, a spouse who is dependent on spousal benefits (those without their own personal earnings record and who aren’t fully insured) will receive benefits based on a lower PIA if the working spouse’s benefits start early.
  • The Earnings Test. Taxpayers who intend to keep working beyond age 62 need to consider the impact of the earnings test, which reduces benefits by $1 for every $2 in earnings above an exempt amount of earnings ($14,640 for 2012) if the taxpayer has not yet reached full retirement age. Thus, the taxpayer’s reduced early retirement benefit would be reduced even further by failing the earned income test.

    Example 2: Charlie retired in 2011 at age 63. In 2012, he works part-time and earns wages of $15,640, $1000 over the exempt amount. Charlie is in the 25% marginal tax bracket (because of additional taxable income) and 85% of his Social Security benefits are included in his gross income. Charlie’s benefits are reduced $1 for each $2 he earns over the exempt amount. Charlie’s additional spendable portion of the additional $1,000 in income after considering taxes and the loss of Social Security benefits is only $301, calculated as follows:

Earnings over the exempt amount $ 1,000
Social Security tax on $1,000 (5.45%)    (55)
Income tax on $1,000 (25% marginal tax bracket)    (250)
Loss of Social Security benefits ($1,000 / 2)    (500)
Tax savings from $500 reduction in benefits ($500 x 85% x 25%)    106
Additional spendable amount  $  301

Factors to Consider in Beginning Benefits after Reaching the Full Retirement Age

A worker born in 1943 or later receives a credit of 8% per year for each year the worker delays receiving benefits after reaching the full retirement benefit age until age 70. This delayed retirement credit can have a significant impact—not only are benefits higher, but the worker’s retirement period will be shorter and the spouse’s survivor’s benefit increased. However, higher earnings after reaching full retirement age won’t increase the worker’s PIA by replacing lower-wage years.

Special Strategies for Increasing Retirement Benefits

Switching from One Type of Benefit to Another. A married taxpayer who has reached full retirement age and wants to earn delayed retirement credits (and thus receive a larger retirement benefit) may, in the meantime, claim a spousal benefit while continuing to work. Then, when the taxpayer has earned additional delayed retirement credits, he or she can switch from spousal benefits to benefits based on his or her own PIA plus the delayed retirement credit. To implement this strategy, the taxpayer’s spouse must already be receiving retirement benefits, for only then may spousal benefits be claimed.

   Example 3: Bo and Jo have both reached full retirement age. Bo wants to retire and start receiving his benefit of $1,800 per month. Jo’s benefit (based on her earnings record) is only $800 per month. So instead, Jo receives the higher spousal benefit of half of Bo’s benefit ($900). However, if Jo chooses to continue working while receiving her spousal benefit, she will continue to earn delayed retirement credits until age 70. At that point, she would be eligible for a larger retirement benefit of at least $1,056 based on her own earnings record (8% delayed retirement credit x 4 years x $800).

Claiming Then Suspending Benefits. Occasionally, a worker will want to delay benefits to take advantage of the delayed retirement credit, while the spouse wants to start spousal benefit immediately. Since spousal benefits can’t be received until the worker has begun drawing benefits, this could create a problem. Fortunately, the worker can file for benefits at full retirement age, thus allowing the spouse to file for spousal benefits, and then immediately suspend benefits to earn the delayed retirement credit. (The worker can also request to “restrict his claim to spousal benefits only” to achieve the same result.)

   Example 4: Al and his wife Jo had both reached their full retirement age. Al’s PIA was $2,000, but he intended to keep working and earn delayed retirement credits until age 70. Jo wanted to retire, but her PIA was only $500. Since Al was not going to retire and receive benefits, Jo was not eligible for her $1,000 ($2,000 x 50%) spousal benefit based on Al’s earnings. However, their planner advised Al to file for benefits so Jo could claim her higher ($1,000 rather than $500) spousal benefit. Then, Al immediately suspended his benefit claim and continued working. Jo was permitted to continue receiving her $1,000 spousal benefit, and Al could continue to accrue delayed retirement credits.

    Variation: Assume that Jo wants to retire at age 62 instead of her full retirement age (66). She files for a reduced benefit of $375. When Al reaches his full retirement age, he files for a spousal benefit of $250 (50% x $500), but continues to work and earn delayed retirement credits. At age 70, he retires and files for benefits based on his earnings history. He stops receiving his spousal benefit of $250, but he now receives his own retirement benefit. The delayed retirement credits he earned have increased his benefit by 32% ($2,640 instead of $2,000).

The increase in benefits caused by the delayed retirement credit does not increase the PIA and does not affect benefits paid to family members other than the worker and, eventually, the surviving spouse. In addition, even after beginning to receive Social Security retirement benefits, a worker can earn a delayed retirement credit for any month that suspension of benefits is requested. This option only applies to the period beginning with the month in which the worker reaches the full retirement age and ending with the month prior to reaching age 70.

The Age 62/Age 70 Strategy. Married workers with a lower-earning spouse and a higher-earning spouse can implement the age 62/age 70 strategy to maximize benefits. The lower-earning spouse applies for reduced benefits at age 62, but the higher-earning spouse delays retirement until age 70. If the lower-earning spouse dies first, the higher-earning spouse keeps his or her own larger benefit. If the higher-earning spouse dies first, the lower-earning spouse receives the higher spousal benefit instead of his or her own reduced benefit.

    Example 5: Ed and Jo are married, and both are age 60. Jo wants to retire at age 62. Her full retirement benefit at age 66 would be $1,451, but her reduced retirement benefit at age 62 will be $1,031. Ed delays his retirement until age 70 (although he may collect spousal benefits when he reaches age 66 since Jo has retired). His full retirement benefit at age 66 would be $2,269, but his retirement benefit at age 70 will be $3,091. At age 66, Ed will file and suspend so Jo can claim her spousal benefit (50% of Ed’s PIA at age 66). When Ed retires at age 70, he will receive $3,091 and Jo will continue to receive her spousal benefit. Then, if Ed dies first, Jo will be entitled to Ed’s full benefit of $3,091.

Note: A study at the Stanford Institute for Economic Policy Research demonstrated that this strategy is equivalent to the return an investor would receive by owning a 7%, government-guaranteed, inflation-adjusted, and (for some recipients) tax-free bond.

© 2012 Thomson Reuters/RIA. All rights reserved.