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How to maximize your Social Security income

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We’ve been subject to a torrent of doom and gloom predictions about Social Security for years. Some financial planners even advise their clients to prepare for a retirement without any Social Security income.

social security card

But a personal financial plan or retirement plan that does not include Social Security income, or one that discounts the value of Social Security, is missing an important component. In fact, ignoring or dismissing Social Security could actually lead to the loss of significant income during your retirement years.

Should you count on Social Security?

Political rhetoric aside, Social Security appears to be in good shape, at least for the wave of Baby Boomers who are now entering retirement age. However, the way Social Security is administered makes it imperative that Boomers take certain steps and make specific decisions now to maximize the benefits they’ll receive from the Social Security Trust Fund once they retire.

Income from Social Security is not insignificant. A recipient earning a monthly benefit of $2,000 today, with an annual cost-of-living adjustment of 2.8 percent, would collect $2,636 per month in 10 years, $3,474 per month if they live another 20 years, and $4,580 per month if they survive for 30 years.

That adds up to a total benefit of $304,256 if the recipient collects Social Security for 10 years. For 20 years, the total is $673,622 in benefits, while collecting for 30 years would bring in total benefits of $1,160,479.

How does the spousal benefit work?

The spousal benefit allows spouses to collect either their own earned Social Security benefit or 50 percent of their spouse’s monthly benefit, whichever is higher. This also applies to spouses who never worked the 40 quarters necessary to qualify for a Social Security benefit of their own.

To qualify for a spousal benefit, an individual must be married at least one year prior to filing and must be at least 62 years old. The spouse must (1) be entitled to benefits, and (2) have filed to collect benefits.

What about survivor benefits?

If spouses both receive Social Security payments and one spouse dies, the surviving spouse will continue to receive the higher of the two monthly benefit amounts.

For example, if one spouse receives $2,000 per month and his or her spouse receives $1,200 per month, upon the death of the first spouse, the surviving spouse’s monthly benefit will increase to $2,000.

Additional rules apply to marriages of less than 10 years at retirement age and for divorced couples.

How much will you get?

To include Social Security income in a retirement plan, you need to know how much you can expect to receive in benefits.

The Social Security Administration uses a formula based on the average of your highest 35 years of earnings, adjusted by three factors, to determine the benefit amount you will receive at full retirement age. These calculations are made when a worker turns 62 years of age.

You may view your projected benefit level by visiting the Social Security website at www.socialsecurity.gov.

One key factor is the age at which a worker files to collect benefits. Currently the full retirement age is 66 for people born between 1946 and 1954. For workers born in 1960 or later, full retirement age is 67.

For those filing prior to their full retirement date, the monthly benefit will be reduced by a specific percentage. For example, people born before 1960 who begin receiving benefits at 62 (the earliest eligible age for retirement benefits) will receive only 75 percent of their earned benefit. They’ll receive 80 percent at 63, 86.7 percent at 64 and 93.3 percent at 65.

It is important to remember that the reduction in benefits remains fixed as long as they collect Social Security. When they reach full retirement age, they will not automatically be restored to 100 percent, but will continue at the reduced amount.

When you factor in cost-of-living increases on a reduced benefit base, choosing an early retirement can significantly reduce the amount of retirement income an individual will receive from Social Security. This income will have to be made up through other sources.

On the other hand, for those who postpone collecting their benefit beyond full retirement age, Social Security “rewards” them by increasing their monthly benefit. If they wait until 67 to retire, they’ll earn 108 percent of their expected benefits. Waiting until 70 will boost benefits to 132 percent.

This incentive to remain in the work force is one way the government is helping to ease the financial crunch on the Social Security Trust Fund. Keep in mind, however, that those who continue to work past their normal retirement age will also continue to pay FICA Social Security taxes.

When is the right time to apply?

So when is the right time to apply for Social Security benefits? Some financial planners advise their clients to apply as soon as they are eligible at age 62. Their reasoning is twofold.

First, they believe the extra four years of income will offset the reduction in the benefits received. This, of course, depends on life expectancy. Individuals who suffer from health problems and do not expect to live long can benefit from taking benefits early. They may, in fact, need the money for medical expenses.

A second, more cynical reason, is a worry that Social Security will indeed “run out of money” sooner than expected, and the recipient should take out as much as possible as quickly as possible.

But we have seen that delaying retirement age can significantly increase benefits later. This is especially true if the person is relatively healthy and expects to live a longer life.

An individual who would earn $2,466 at age 66 but waits to begin benefits until age 70 – and then lives to be 90 years old – will enjoy a monthly income at age 90 of $7,053.

Clearly, the longer a person lives, the more beneficial it is to delay benefits. Be sure not to overlook the value of an increased monthly benefit to the surviving spouse, especially if the surviving spouse is younger and likely to collect survivor benefits for many years.

How does continuing to work impact benefits?

Another issue involves those who intend to continue to work. Those who begin to collect Social Security benefits before full retirement age and continue to work, either full-time or part-time, will be subject to an annual earnings test in which $1 of benefits will be withheld for every $2 earned above the exempt amount – $15,120 in 2013 and $15,480 for 2014.

This withholding will stop when wage earners reach full retirement age. For those who continue to work past full retirement age, benefits will not be withheld, but up to 85 percent of their Social Security benefits may be taxable.

How can benefits be maximized?

Social Security benefits are based on an average of a person’s annual income, up to the Social Security taxable wage base ($113,700 in 2013), during their 35 most productive working years.

Believe it or not, sometimes the Social Security Administration gets those numbers wrong. It is essential to review your personal statement on an annual basis at www.socialsecurity.gov. If there are errors, inaccuracies or missing years, you should contact the Social Security Administration immediately to have them corrected.

One strategy for a couple to maximize benefits is to “file and suspend.” Here’s how it works: The higher-earning spouse applies for benefits at full retirement age, but then asks to delay the benefits until age 70.

The lower-earning spouse then applies for the spousal benefit – 50 percent of the higher-earning spouse’s benefit. The couple collects the spousal benefit while earning delayed credits on the higher-earning spouse’s benefits.

An alternative to this is for the lower-earning spouse to file and collect benefits while the higher-earning spouse applies for a spousal benefit, collecting half of the lower-earning spouse’s benefit amount. Then, at age 70, the higher earner can switch to his or her full benefit, which is now generating more income thanks to a four-year delay.

Social Security income may be subject to income tax. Married couples filing jointly with “provisional income” above $32,000 ($25,000 for single payers) will find 50 percent of their Social Security benefits taxable.

The taxable amount rises to 85 percent when “provisional income” is more than $44,000 for couples and over $34,000 for single taxpayers. (Provisional income is modified adjusted gross income plus half of Social Security income plus tax-exempt interest.) Still, having only part of Social Security benefits taxed is better than having all of it taxed.

Most people will not be able to live on Social Security alone during retirement. Income from Social Security must be part of an overall plan that includes pensions, IRAs, investments, and, in many cases, ongoing income from work.

Still, Social Security benefits can provide a significant amount of income that should not be dismissed or ignored in retirement planning. With the right information and timing, everyone should be able to maximize this important source of retirement income.