As one of the two largest “entitlement” programs, Social Security is at the forefront of the deficit and fiscal debates. At this point, any changes to Social Security are stalemated with everything else in Washington. In the meantime, millions of baby boomers will be struggling with the decision of when to start taking their Social Security benefit.
A worker qualifies for a Social Security retirement benefit by working for 40 quarters (10 years, although the quarters do not have to be consecutive) in a job which participates in Social Security. The earnings and Social Security contributions records from that work creates a “primary insurance amount” (PIA) which is available at the “normal retirement age” (NRA). NRA is age 66 for those born between 1943 and 1954 and increases in two month increments to age 67 for those born in 1960 or later. (Disability and survivor benefits have their own sets of rules.)
The decision lies in the ability to begin receiving Social Security benefits at any time after reaching age 62. The PIA is reduced, however, depending on how long before NRA the benefits begin. For the first three years prior to NRA, the PIA is reduced by 6 2/3% per year and for years four and five prior to NRA the PIA reduced by 5% per year. That means for someone with NRA of 66, the PIA is reduced by 25% if taken at age 62 (three years times 6 2/3% and the last year at 5%).
But Social Security also presents an opportunity to increase the benefit. For all workers born in 1943 or later, the PIA is increased 8% per year for every year after NRA, up to age 70. For a worker with NRA of 66, the benefit would be increased by 32% if delayed until age 70. In this era of low interest rates and volatile markets, an 8% annual increase is hard to beat.
Here are some of the primary factors when considering when to take the Social security retirement benefit.
- What’s the need? With high unemployment and fewer employers offering pensions, many workers have little choice but to take their benefit to meet basic living needs. However, while somewhat counterintuitive, it may make more sense in the long run to use other savings to bridge the income gap and wait for a higher Social Security benefit.
- Still working? In addition to a reduced PIA, the benefit is reduced if earned income (including self-employment) exceeds certain levels prior to NRA. The benefit is reduced by $1 for every $2 earned above $14,460 for the year (there are special rules for the year in which NRA is reached). This further reduction ends when earned income falls below $14,460, but having earned income can significantly reduce any advantage of taking the benefit early.
- How are you feeling? Any reductions or increase in the PIA, based on when the benefit is taken, are permanent. By design, Social Security is “actuarially neutral”, meaning that a recipient would receive the same total benefit, regardless of when they began receiving their benefit, if they live to the standard life expectancy. That standard life expectancy, however, does not take into account individual or family health histories or even gender. Most analyses show the “break even” (the point at which the higher benefit from waiting to NRA or later catches up to receiving more years of a reduced benefit) to be in the early to mid-80’s.
- How sure are you? Until recently, one strategy was to take Social Security early and, well past NRA, pay back all the benefits received and refile at a higher benefit. There was no interest charged on the amount paid back and so this was a good way to “hedge” the possibility of an early death. This strategy has been greatly restricted, with payback now only available in the first 12 months after beginning benefits.
- Other unearned income? Social Security benefits are subject to federal income taxes based on the total of ½ of the Social Security benefit plus all other income, including all retirement plan withdrawals, investment income and tax exempt interest. If this total is less than $32,000 for a married couple (less than $25,000 for a single person), the Social Security benefit is not taxed at all. If the total is between $32,00 and $44,000 for a couple ($25,000 to $35,000 for single), 50% of the benefit is taxed, and over $44,000 for a couple (over $35,000 for single), 85% of the benefit is taxed.
- Two-earner couple? Another common strategy for married couples is for the spouse with the lower PIA to take an early benefit and for the spouse with the higher PIA to delay taking the benefit as long as possible. If the lower-earning spouse dies first, the survivor is left with the higher benefit for life. If the higher-earning spouse dies first, the survivor is then entitled to the higher benefit as a surviving spouse.
- Get it while you can? This emotional response is based on both the fear that Social Security will change after age 62 and the sense that, having paid into the system for years, the benefit is a genuine entitlement. However, even serious proposals to change Social Security don’t affect workers past age 55 (or age 60 at the worst), so once the benefit becomes available it is unlikely to change. And while it is hard to accept that somehow the benefit received may not equal the amount contributed, if the recipient lives to the standard life expectancy the benefit will indeed exceed the contributions.
With the exception of genuine need, none of these factors alone is really decisive. As with most financial decisions, when to take Social Security relies on personal circumstances and priorities. Understanding the options and implications, however, will result in a much better decision.