EXECUTIVE
SUMMARY | In determining the
age at which a worker should apply
for Social Security benefits,
consideration should be given to current
and expected future sources of income, age
of beneficiary and spouse, health issues
that could affect longevity and whether
the beneficiary will continue to work
while receiving benefits.
There is no
“one-size-fits-all” answer
for deciding when Social
Security benefits should be started.
Many workers will benefit by beginning
to receive benefits at age 62 due to
their circumstances and needs. For
others, waiting until full retirement
age, or even later, will provide higher
annual income in the years ahead when
their expenses might outpace their
resources.
How long does it
take to break even in the
game of taking benefits at early vs.
normal retirement age? If two retirees
are now 65 and one started collecting
Social Security benefits at age 62 and
the other starts now, they will collect
the same total amount of money when they
are 77 years old.
It’s important to
do preretirement calculations
at least every three years, to
take into account any changing
circumstances and/or changes in the
rules as they apply to Social Security
benefits, pensions and investment
savings.
Kathryn Garnett
is a nationally recognized speaker
and educator who specializes in
helping Americans of all ages
understand the complexities of the
Social Security System. Her e-mail
address is
kathrynlgarnett@comcast.net
.
|
hat’s the best age to
begin collecting Social Security benefits? Is it
62? 65? 67? Here’s a guide to help you maximize
your financial security—and that of your
clients—through your 60s and beyond. H OW
THE S YSTEM W ORKS In order for workers to
receive Social Security benefits, they must meet
certain criteria. The basic requirement for
eligibility is the accumulation of 40 work credits
during one’s working life. A worker earns one work
credit for predetermined dollar earnings ($970 in
2006), to a maximum of four work credits in any
calendar year. Full-time workers earn this easily
in the early part of the year; even part-time
workers can earn the requisite work credits within
10 years. The second computation is the
average of the worker’s highest 35 years of
earnings. These years need not be consecutive, but
any “0” years lower the average. The good news is
that earnings are adjusted for inflation. An
inflation factor is applied to all earnings before
age 60, making them approximate current dollars.
The amount of the benefit a worker receives is a
percentage of that calculated amount.
Early Birds
About 50% of men and 60% of
women take Social Security benefits at
age 62.
|
Because the intent of Social Security is to
provide a safety net for low-income workers, the
system is designed to provide higher benefits to
this group. Where a high-income worker might
receive replacement of about 25% of income,
workers who earned minimum wages throughout their
working lives might receive as much as 62% pay
replacement.
Where It All Began
In the 1930s, while the
country still was reeling from the Great
Depression, it became evident that
senior citizens were among those most
adversely affected. As part of his New
Deal, President Franklin D. Roosevelt
introduced the Social Security System,
with the goal of keeping elders above
the poverty line. There was not then,
nor has there ever been, any premise
that Social Security would be a
retiree’s sole income. The program was
designed to provide a safety net to
ensure that senior citizens could
maintain at least a minimum standard of
living. The bulk of retirement living
expenses always has been from other
sources such as pensions and personal
savings.
| The third
variable in determining your benefits is the age
at which you begin to draw them (see exhibit 1 ). In the early
1980s, in order to meet a potential shortfall in
funding, Social Security revised the “Full
Retirement Age” schedule, spreading out the age at
which workers could receive full benefits from the
system. The ability to draw early benefits at age
62 did not change, but be aware that discounts
apply for early payment of benefits. The discount
for early payment of benefits is calculated in two
stages. For the first 36 months of early filing,
payment is reduced 5 / 9 of 1% per
month; then payment is reduced 5 / 12
of 1% for each additional month. As an example, if
you opt to begin your benefits at 62 and your full
retirement age is 66, you will be drawing your
benefit four years—or 48 months—early. Your
payment would then be about 75% of your full
benefit. When you opt for this early benefit, you
will continue at this lowered amount throughout
your life.
|
Full Retirement Age
|
Year of
birth |
Normal
retirement age
|
Payment
at 62
|
1937 or
earlier
|
65
|
80% of
full benefit
|
1938
|
65 &
2 months
|
79.2%
|
1939
|
65 &
4 months
|
78.3%
|
1940
|
65 &
6 months
|
77.5%
|
1941
|
65 &
8 months
|
76.7%
|
1942
|
65 &
10 months
|
75.8%
|
1943–1954
|
66
|
75%
|
1955
|
66 &
2 months
|
74.2%
|
1956
|
66 &
4 months
|
73.3%
|
1957
|
66 &
6 months
|
72.5%
|
1958
|
66 &
8 months
|
71.7%
|
1959
|
66 &
10 months
|
70.8%
|
1960 and
later |
67
|
70%
| | |
A DVISING C LIENTS When a client asks a
CPA for advice on when to begin taking benefits,
many factors need to be considered. We’ll review
some of the reasons to take benefits early, at
full retirement age or at a later date.
Early
benefits. Why begin your
benefits at the earliest possible age? Let’s
consider two examples. Monica has worked hard all
her life, but never was able to earn more than
low-level wages. Now she is nearing 62 and finding
that her health is going to force her into
retirement earlier than she had planned. She has
not worked for large employers who provide pension
benefits nor has she had access to a 401(k)
savings plan. She does not own a home. Monica will
be dependent upon her Social Security benefits for
subsistence after she leaves the workforce. With
no other income available and little prospect of
future employment, she’ll need to apply for her
Social Security benefit at the earliest possible
time. Sam has had a reasonable work income
for many years and at 64 is planning to slow down.
While he will continue working for several more
years, he wants to cut back on physical work. Sam
will need more income than part-time work can
generate. He can continue to maintain his current
lifestyle by adding Social Security to his
resources.
Early benefits—pros and cons.
Early benefits can provide the
much-needed safety net for anyone who has no other
source of income, or whose income is not
sufficient to cover day-to-day living needs.
However, this lowered benefit will not increase at
full retirement age, so, with the exception of
cost-of-living increases, the retiree can expect
to have the lowered income for the rest of his or
her life. Still, the spouse will receive a certain
percentage of the worker’s full retirement
amount (the benefit payable to the worker
at full retirement age). Another
consideration is the penalty that is attached to
some earnings when you receive Social Security
benefits. Each year Congress establishes a maximum
amount that working beneficiaries already
collecting retirement benefits can earn without
penalty. Prior to full retirement age, any amount
earned over that maximum is penalized; 50% of the
“excess” earnings are deducted from the Social
Security benefits. This earnings maximum and
penalty apply only prior to reaching full
retirement age. After reaching full retirement
age, the beneficiary can earn any amount without
penalty.
Full
retirement age. There are
good reasons for beginning to take benefits at
full retirement age, which now is set between 65
and 67. For example, let’s take the case
of Catherine, who for most of her life has been a
full-time worker and a dedicated saver in her
401(k) plan. Although she has reached her full
retirement age, she does not plan to retire for
several years. Even though she does not need the
income she will receive from Social Security at
this time, she will put it in a savings account to
provide income when she does retire in a few
years. Since there is no penalty on earnings after
reaching full retirement age, Catherine will
benefit from accumulating a nest egg for her early
years of retirement and postpone drawing from her
tax-deferred savings until she reaches the age of
70 1 / 2 .
Full retirement age—pros and cons.
The full benefit one has earned is
available without any penalty at normal retirement
age, and the beneficiary can continue to work with
no lowering of Social Security benefits. However,
if the beneficiary earns substantial income, a
large portion of the Social Security payment may
be subject to federal income tax. (See “Taxation
of Social Security.”)
Late
benefits. Now, let’s look
at examples of why people might wait beyond their
full retirement age to begin drawing their Social
Security benefit. Eldon has been a successful
businessman for the past 40 years, holding
executive positions that have paid him more than
the annual earnings limits. He can expect to draw
the maximum benefit of $2,053 a month when he
reaches full retirement age. He also has deferred
the maximum into his 401(k) plan, which now has a
substantial balance that will easily fund his
retirement years. Since he does not need the
additional funds during his early retirement
years, Eldon will wait until he is 70 to begin
receiving his Social Security benefit, which by
then will be nearly $2,700, thereby assuring a
larger safety net should his investments drop in
value, and also assuring his spouse a higher
income should he predecease her. Irma has
worked as a professional most of her adult life.
As she looks at her future finances, she considers
her longevity in light of the fact that her
parents and grandparents all lived to be close to
100 years of age. Knowing that she may live longer
than the average person, and that her medical
expenses may soar in her later years, Irma chooses
to delay her Social Security benefits. For now she
has sufficient resources to maintain her standard
of living, but she realizes that her needs may
exceed her resources down the road. By waiting
until age 70, Irma knows her current benefit of
$1,685 a month will grow to $2,207.
Late benefits—pros and cons.
The lure of higher payments makes
late benefits appealing to many people. But none
of us knows how long we will live. Postponing
benefits could mean less benefits, or none at all,
should we die before beginning withdrawals. The
increase in benefits (which is about 8% per year)
lasts only until age 70; after that benefits
remain at the 70-year-old level. If a
worker lives to full life expectancy, he or she
will receive the same dollar total from the Social
Security Administration (SSA) whether benefits
started early, at full retirement age or late.
Early recipients get more but smaller checks;
later recipients get fewer but larger checks.
Actuarially, it’s a wash, so other considerations
must be the deciding factors. |
Planning for Social
Security
BY TED SARENSKI
“S ocial
Security will not be around by
the time I retire” is a
statement often made by
members of the baby-boom
generation and those younger.
Why even read an article
regarding collection of Social
Security benefits if they
won’t be received? A look at
the 2005 annual report from
the Social Security and
Medicare Boards of Trustees
reveals that it will be around
for generations of Americans
who will reach retirement age
in the future. The
report estimates that Social
Security could be brought into
actuarial balance over the
next 75 years by increasing
the amount of payroll taxes
being currently charged by
15%, reducing current benefits
by 13% or some combination of
the two. The longer changes to
the benefit system are
delayed, the costlier the fix
becomes. The report states
that if no changes are made,
the average benefit would need
to be slashed to 74% of the
projected benefit in 2041, the
estimated year that trust fund
outflows would need to equal
inflows for the program to
remain solvent.
Medicare’s projected
shortfall is predicted to come
much sooner than the Social
Security shortfalls, as health
care costs are rising faster
than workers’ wages. The Board
of Trustees estimates the
Medicare funds shortfall will
occur by 2020 at the current
rate of collection and
payment. It suggests an
immediate increase of 107% in
income to the program or an
immediate reduction by 48% in
benefits being paid, or a
combination of the two, to
keep the program solvent for
the next 75 years. As with
Social Security, the cost of
solutions increases with
delayed response. The
Board of Trustees report
explains the statistical and
actuarial processes used in
arriving at their conclusions
but never, in any section,
suggests the Social Security
or Medicare programs will
disappear. It is important,
however, for our society to
address the issues earlier
rather than later. As
the defined benefit pension
plans of a generation ago have
dwindled, individuals need
greater personal savings in
the form of larger 401(k) plan
contributions, IRA
contributions and after-tax
savings to fund their desired
standard of living in
retirement. Company-sponsored
pension plans have not
disappeared, but neither they
nor Social Security can be
relied on to fully support
someone’s standard of living
in retirement. Still, Social
Security is a very important
piece of our society’s safety
net that needs to be preserved
for future generations.
Ted Sarenski,
CPA/PFS, is the founding
member of DB&B Financial
Services in Syracuse, N.Y.
His e-mail address is
tjs@dbbllc.com
.
| |
BREAKING EVEN
How long does it take to break even in the
game of taking benefits at early vs. normal
retirement age? Let’s take Joan and Mary as
examples. Both are now 65 years old. Joan started
collecting benefits at age 62; Mary is just
beginning to collect now, at age 65. Because Joan
has had a three-year head start on collecting
benefits, it will take Mary 12 years to catch up.
It will not be until they are both 77 years old
that they will have collected the same total
amount of money. After that, since Mary will
continue to receive a bigger check every month,
the total amount of Social Security she collects
will be larger than Joan’s total. So the
break-even age is 77. The average retiree who
begins taking benefits early will come out ahead
only if he or she dies before that age, and the
average retiree who waits until full retirement
age will collect more money only if he or she
lives longer than that. The SSA provides
each worker with a benefit estimate every year.
This is important information for CPAs working
with clients in planning for their financial
health in retirement. As circumstances change and
rules regarding Social Security, pensions and
various investment vehicles are updated, it is
important to review and adjust retirement
calculations at least every three years. You may
request this information through the SSA Web site
( www.ssa.gov ),
by calling 1-800-SSA-1213 and requesting the
Personal Statement Request Form (SSA-7004), or by
using “AnyPIA” Computation Software (available at
www.ssa.gov/OACT/ANYPIA/compute.html
) on your PC.
|
Consider clients’
health and other sources of
income, among other things, when
advising them on whether to take
benefits early, at full
retirement age or late.
Make your clients
aware of the tax implications
of earning wages while
receiving Social Security
benefits.
| |
TAXATION OF SOCIAL SECURITY
Your clients should be prepared to pay
income tax on some Social Security benefits. There
are two steps to determine how much of the benefit
is subject to taxation:
Find the sum of the following three
amounts: adjusted gross income, nontaxable
interest income (for example, from municipal
bonds) and “countable” Social Security (half of
the yearly Social Security amount).
Compare this result to the IRS base
amount (for 2006 this is $32,000 for a married
couple and $25,000 for an individual). If
the result of Step 1 exceeds the IRS base amount,
0% to 85% of the Social Security benefit is
taxable. The IRS tax return instructions provide
the formula for determining the individual’s tax
liability. An example for a married
couple:
Adjusted gross income: |
$30,000 | Nontaxable
interest income: | $3,000
| 50% of annual Social
Security of $16,000: | $8,000
| | $41,000
| Since $41,000
exceeds the IRS base amount of $32,000 for a
married couple, they would use the IRS
instructions to determine their individual tax
liability. See exhibit 2 for
the best age for married couples to begin
collecting Social Security benefits.
|
Best Ages for Married
People to Claim Social Security
| Here’s the
optimal plan for a married
couple in good health:
|
Age
difference
| Wife’s
earnings as
percentage of
husband’s
|
|
0%–30%
|
30%–40%
|
40%–100%
|
0 years
|
66
husband, 66 wife
|
67
husband, 66 wife
|
69
husband, 62 wife
|
3
|
68, 65
|
69, 62
|
69, 62
|
6
|
68, 62
|
69, 62
|
69, 62
|
Source: Alicia H. Munnell
and Mauricio Soto, Center for
Retirement Research.
| |
PEOPLE NEED GUIDANCE
Trying to find their way through the Social
Security System often leaves American taxpayers
feeling at a loss, and many need professional help
when making decisions that will have a long-term
effect on their financial picture. Using the
examples above, CPAs can help clients weigh their
options, consider their individual situations and
determine the best course for receiving this
valuable entitlement.
|
AICPA
RESOURCES
| Conference
AICPA Advanced Estate Planning
Conference San Diego
July 26–28
CPE
Retirement Planning That Works
for Your Client (# 730840JA).
For more information, to
place an order or to register,
go to
www.cpa2biz.com or call
the Institute at 888-777-7077.
OTHER RESOURCES
AARP
Publications
800-424-3410;
www.aarp.org/money/social_security
. Offers articles of
current interest on all areas
of Social Security, including
a retirement calculator.
Social Security
Administration
800-772-1213;
www.ssa.gov Sign
up for the SS eNewsletter,
apply for benefits, ask a
question and read the annual
Trustees’ Report. | | |