Social Security: What’s the Magic Age?

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.

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.

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.

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.

Practical Tips

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:

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.