One of the most critical decisions in retirement planning is when to draw Social Security benefits. While there are many pieces to consider, this newsletter will look at three important factors to think about when taking Social Security benefits.
1. Marital Status
Are you married, divorced, single, or widowed? Many people approach the question of when to draw Social Security benefits as if they were single. Unless you have never been married, the decision should be viewed jointly, even if your spouse is no longer living or you are no longer married.
If taken at full retirement age (FRA), the full spousal benefit could be up to 50% of the partner’s FRA amount. The spousal benefit is usually favorable for nonworking spouses or spouses who had lower incomes for many years. An individual may file for spousal benefits as early as age 62 but will receive a permanently reduced benefit amount for life if they file early. To receive spousal benefits, the spouse must be receiving their retirement benefits (except for divorced spouses). One could begin drawing their benefit at age 62 and then switch to the spousal benefit once their spouse begins drawing benefits. However, their spousal benefit would be less than 50% of the worker’s amount because they started drawing early. An individual could also claim survivor’s benefits on a deceased spouse’s earnings record. Reduced benefits can be taken as early as age 60 for widows or widowers.
When married couples are planning to draw benefits, it is essential to think about joint life expectancy. Because the highest earner determines the spousal benefit, the goal should be to maximize the highest earner’s benefit.
Widows and Widowers
Upon the first spouse’s death, the survivor receives the higher of the two benefit amounts. It is generally advisable to have the person with the higher benefit amount wait until at least FRA to start their benefit. This maximizes cumulative lifetime benefits for a couple in cases when one spouse may expect to outlive the other—similar to choosing the survivorship option when drawing a pension. If a deceased worker started receiving reduced retirement benefits before FRA, a special rule called the retirement insurance benefit limit might apply. The retirement insurance benefit limit is the higher of:
- The reduced monthly retirement benefit to which the deceased spouse would have been entitled if they had lived, or
- 82.5% of the unreduced deceased spouse’s monthly benefit if they had started receiving benefits at their FRA
Married Couples
The spouse with a lower earnings history should generally wait until their FRA to draw benefits. They could begin drawing their benefit until their spouse starts drawing benefits and then switch to spousal benefits if the amount is higher. A retiree claiming benefits based on their record can put off receiving benefits after FRA in exchange for “delayed retirement credits.” Benefits continue to increase each month up until age 70. However, spousal benefits do not increase after FRA. There is no financial benefit to a lower-earning spouse if they wait past FRA to claim Social Security.
Keep in mind that claiming Social Security benefits before FRA results in a permanent reduction in the benefit amount, whether you are claiming spousal benefits or your own. Claiming benefits at the earliest possible age of 62 can reduce benefit amounts by as much as 30%1.
2. Fully Retired vs. Working Part-Time
In addition to a reduced benefit when drawing early, an earnings test penalizes benefits for someone who is still working. The earnings test applies to earned income (wages or self-employment income), not investment income or retirement income. Social Security benefits will be reduced if total earnings exceed the annual limit:
| Earning Limits |
| Under federal law, people who are receiving Social Security benefits, and who have not reached full retirement age, are entitled to receive all of their benefits as long as their earnings are under the limits indicated below. For people born in 1943 through 1954, the full retirement age is 66. The full retirement age increases gradually each year until it reaches age 67 for people born in 1960 or later. |
| 2020 | 2021 | |
| At full retirement age or older | No limit on earnings | No limit on earnings |
| Under full retirement age | $18,240 For every $2 over the limit, $1 is withheld from benefits | $18,960 For every $2 over the limit, $1 is withheld from benefits. |
| In the year you reach full retirement age | $48,600 For every $3 over the limit, $1 is withheld from benefits until the month you reach full retirement age. | $50,520 For every $3 over the limit, $1 is withheld from benefits until the month you reach full retirement age. |
Source: SSA.gov
If you reach FRA after 2021, $1 of your benefits will be withheld for every $2 in excess earnings. If you attain FRA during 2021, $1 of your benefits will be withheld for every $3 in excess earnings, and only earnings in the months before your birth month will be considered.
3. Income Taxes
Finally, an effective Social Security strategy should take tax implications into consideration. Depending on the retiree’s income, up to 85% of benefits could be taxed. Despite inflation, the income levels for taxing Social Security benefits haven’t changed for decades. In the first year that Social Security became taxable, less than 10% of retirees paid federal income tax on their benefits. Today, about 40% pay tax on some portion of their benefits, and that is expected to climb to over 50% in three decades.
An effective drawing strategy might include delaying benefits to make Roth conversions before age 72. Required minimum distributions at age 72 could make a large portion of Social Security benefits taxable. Having an IRA converted to a Roth before drawing benefits could minimize taxation of Social Security while also maximizing delayed retirement credits.
Social Security benefits should play a role in your retirement plan, but they shouldn’t be the only method of funding your retirement. At Rodgers & Associates, our financial planners look at the entire picture: taxes, investments, risk management, and more. It’s the coordination of many aspects of your financial plan that helps us take advantage of opportunities.
Rick’s Insights
- Couples should devise a claiming strategy to maximize Social Security benefits over their joint life expectancy.
- The spouse with a lower earnings history should generally wait until their FRA to begin drawing benefits.
- An effective Social Security strategy should consider tax implications.
