How to help clients make the right Social Security election

As the wave of Baby Boomer retirements continues, it is more important than ever for CPAs to understand how to help clients be in the best position to maximize Social Security benefits. Mastering the intricacies of the rules is no easy task, especially for accountants who don’t concentrate full time on financial planning. Fortunately, a CPA does not have to be a Social Security expert to raise the topic with clients or answer basic questions. To help CPAs get started, this article presents a primer on what to consider when making the Social Security election.

To simplify the process, a CPA should ask the client to focus on four key aspects of the decision:

1. Which filing status yields the best benefit?
2. Are there reasons for a benefit reduction?
3. What issues affect the timing of starting the benefit?
4. Has the client carefully considered the longevity protection provided by Social Security?

Understanding these concepts allows the client to make a better informed decision regarding how to apply for and when to begin receiving Social Security. This article takes a look at each concept.

1. Filing Status
Social Security has several categories of beneficiaries. It is likely that clients are entitled to benefits in more than one category:

• Worker;
• Spouse or ex-spouse of a worker;
• Survivor of a worker (widow/widower; minor child/older disabled child; or financially dependent elderly parent at the time of the worker’s death);
• The dependent of a worker (minor child/older disabled child).

A beneficiary may fit into more than one category. For instance, he or she may have earned both his or her own worker’s benefit and also be entitled to benefits as a spouse. To fit into a particular category, the beneficiary may have to meet other requirements. For example, for an ex-spouse to receive benefits, he or she must, among other requirements, have been married to the worker for at least 10 years before the divorce. 

To maximize a client’s benefits, a CPA may recommend that a benefit be filed for in one category and later switched to another category. For example, lifetime benefits for a couple may be maximized if a client at full retirement age (FRA) files first for his or her spousal benefit and at age 70 switches to his or her own worker benefit. The FRA is the age at which a beneficiary is entitled to his or her full benefit. For Baby Boomers, the FRA is age 66 or older (see Exhibit 1).

2. Benefit Reductions
Two rules can substantially reduce Social Security benefits. These are (1) the government pension offset (GPO) and (2) is the windfall elimination provision (WEP). Only clients who have worked for, or whose spouse has worked for, uncovered wages are affected by these provisions. Uncovered wages are wages paid to a worker that are not covered by Social Security. Examples include many state and local government jobs—such as teaching positions. While both the WEP and the GPO reduce benefits, each provision affects different types of payments depending on the individual’s filing status:

• The WEP reduces the Social Security worker’s benefit paid to an individual with uncovered wages. Additional information on the WEP and an online calculator are available at tinyurl.com/7dbjze8.
• The GPO reduces (and in some cases, eliminates) any Social Security spousal or survivor benefit of a spouse who earned uncovered wages. If the GPO applies, the Social Security spousal or survivor payment must be reduced by two-thirds of the government pension. Additional information on the GPO and an online calculator are available at tinyurl.com/7vs34xh.

It is important to ask the client if he or she ever earned uncovered wages and, if so, to understand how they will affect retirement income. Social Security benefit statements (available at socialsecurity.gov) provided prior to claiming benefits do not state whether the benefit paid will be reduced by the GPO or the WEP.

Accountants can refer to SSA Publication No. 05-10007, Government Pension Offset, for additional information on the GPO. Additional information on the WEP is available in SSA Publication No. 05-10045, Windfall Elimination Provision. Both are available at socialsecurity.gov.

3. Timing
Social Security provides eligible individuals flexibility regarding the timing of receiving their benefits. The worker’s benefit may begin as early as age 62, as late as age 70, or any time in between. The participant’s full benefit is determined as of his or her FRA. This full benefit is also known as the participant’s primary insurance amount (PIA). The PIA is used to calculate the reduction for the worker taking his or her benefit early and to calculate the increase if the worker decides to delay his or her benefit until after FRA. The PIA is also used to calculate a spousal benefit.

If a benefit is filed before reaching FRA, the PIA may be decreased by as much as 30%. This represents an actuarial reduction of the full benefit that would otherwise be paid at FRA. The actuarial reduction recognizes that if the participant files for an early benefit at any time before FRA, he or she will be receiving a monthly payment for a longer time than if the participant waited until FRA. To make up the difference, each check is reduced. The reduction is permanent, although annual inflation adjustments will still be made.

If a benefit is filed for at FRA, the worker is paid his or her full benefit. If a benefit is filed for after FRA up to age 70, the monthly payment could increase by as much as 32% due to the application of delayed retirement credits (DRCs). DRCs increase the monthly benefit by 8% for every year of delay between FRA and age 70. DRCs stop after age 70. This increase recognizes that if the worker delays receipt of his or her benefit until after FRA, fewer checks will be received over the recipient’s lifetime. To offset this, each check is increased by the DRCs.

There are, of course, good reasons not to delay Social Security payments. For example, if a client is chronically ill and expects to die relatively young, filing for benefits at age 62 makes sense. An early start also may be necessary if the client has no other financial resources and cannot afford to delay.

As a general rule, it is better for a client to delay taking Social Security benefits for as long as possible to maximize lifetime benefits. For planning purposes, the decision of when to file should take into account one final factor that is often overlooked—the longevity protection that Social Security provides.

4. Longevity Protection
Because people rarely know exactly how long they will live, there is always a possibility that a client will outlive his or her retirement savings. Planners use longevity protection strategies to safeguard against this. The goal is to prevent clients from running out of retirement savings or to help them receive the largest Social Security benefit possible if that happens.

Social Security is an annuity that a client can’t outlive. The client can maximize the size of that annuity by delaying taking the larger monthly benefit until age 70. While it requires patience on the client’s part, there are long-term benefits. Delaying means that clients and their surviving spouse, if any, will receive larger Social Security benefit payments, which will help if they exhaust their retirement savings. Those larger checks also can help offset the increased health care and custodial costs often associated with old age.

Longevity protection is important whether a participant is single or married. If a client is single, only the participant’s life expectancy is a concern. If a client is married, however, the life expectancy of the second to die is a key factor that is often overlooked.

Many advisers rely on a simple break-even analysis as the only factor in making the timing decision. As previously mentioned, a client receives more lifetime checks but a reduced benefit if the Social Security benefit is elected early. A delay means fewer lifetime checks but larger monthly payments.

The break-even analysis compares the lower payment received each month if an early election is made with the larger payment received if the election is delayed. For example, assume the client can elect a benefit at age 62 that is $750 per month or wait until age 70 to receive $1,320 per month. In this simplified example, if the client lives to age 80 or longer, he or she will be better off delaying taking a benefit to age 70. That’s because at age 80 the cumulative benefits paid under each election will be approximately equal. Living beyond age 80 will result in more cumulative benefits being paid under the delay strategy. If the client expects to die before age 80, taking a benefit early is the better strategy.

The break-even analysis fails, however, to take into account Social Security’s longevity protection. This protection is very valuable and should not be overlooked.

The issue of early election versus delay is especially important to the surviving spouse. Many surviving spouses step into the larger benefit being paid to the deceased spouse at his or her death. At the same time, however, the survivor loses the lower Social Security benefit he or she had been receiving prior to the spouse’s death. Delaying Social Security allows the survivor to step into a larger benefit.

INTERACTION

Planning for a married couple has to be done carefully. Either spouse’s election regarding his or her own worker’s benefit can limit the planning alternatives. The most obvious example is an early election by the higher-earning spouse to take her worker’s benefit. That may affect her husband’s income if he survives her.

In some cases, it may make sense for the higher-earning spouse to file for spousal benefits. In the typical scenario, the lower-earning spouse files for spousal benefits. In the case of the higher-earning spouse, electing spousal benefits at FRA allows his or her worker benefit to increase due to DRCs. In the meantime, the spousal benefits will make up some of the loss in income from FRA to age 70. In this case, if the lower-earning spouse files for spousal benefits first, the higher-earning spouse is precluded from also filing for spousal benefits. Both spouses cannot receive spousal benefits at the same time. Social Security decisions must be made as a couple to properly coordinate benefits and successfully implement the plan.

Because planning to maximize lifetime Social Security benefits depends on how long the client will live, it is, at best, an educated guess. With proper Social Security planning, a CPA can put the client in the best position to maximize benefits. By focusing the client’s attention and understanding on the four key factors, a planner can move the client from an initial inclination to take benefits early and position him or her to receive much greater value from Social Security over a lifetime.

EXECUTIVE SUMMARY

The current and pending wave of retirements of the Baby Boomer generation makes it more important than ever for CPAs to understand how to help clients maximize Social Security benefits. To get started, advisers should concentrate on four key aspects of when clients should begin receiving benefits.

Social Security has several categories of beneficiaries. Advisers need to determine which filing status yields the best benefit for clients.

Two rules can substantially reduce Social Security benefits: the government pension offset and the windfall elimination provision.

Social Security provides eligible individuals flexibility regarding the timing of receiving their benefits. The worker’s benefit may begin as early as age 62, as late as age 70, or any time in between.

Because people rarely know exactly how long they will live, it is always possible that a client will live long enough to exhaust his or her retirement savings. Planners need to use longevity protection strategies to safeguard against this.

James Sullivan (sullivanprimeplus@sbcglobal.net) is a financial planner in Wheaton, Ill.

To comment on this article or to suggest an idea for another article, contact Chris Baysden at cbaysden@aicpa.org or 919-402-4077.

AICPA RESOURCES

JofA articles

• “PFP Q&A: Planning for Change,” July 2013, page 36
• “Social Security for Two,” Jan. 2009, page 30
• “Social Security: What’s the Magic Age?” July 2006, page 28

Publication

The Adviser’s Guide to Social Security: Unlocking the Mystery of Retirement Planning, Second Edition (#PPF1303P, paperback; and #PPF1303E, ebook)

CPE self-study

• 2013 Hot Tax Topics: Get Up to Speed on the Hottest Tax Topics (#733137)
• Social Security and Medicare: Advanced Analysis of the Tactics, Taxes, and the Truth (#745275)

Conferences

• Implementing Personal Financial Planning Services: Step-by-Step Plans for Success, Jan. 18–19, Las Vegas
• Advanced Personal Financial Planning Conference, Jan. 20–22, Las Vegas

For more information or to make a purchase or register, go to cpa2biz.com or call the Institute at 888-777-7077.

Practice tools

• The CPA’s Guide to Social Security Planning
• The Personal Finance Report Card
• Tax Practitioner’s Toolkit

PFP Section and PFS credential

Membership in the AICPA Personal Financial Planning (PFP) Section provides information, tools, advocacy, and guidance to CPAs who specialize in providing tax, retirement, estate, risk management, and investment advice to individuals and their closely held entities. For more information, visit the PFP website at aicpa.org/PFP. Members who want to demonstrate their expertise in this subject matter through testing, experience, and education may benefit from seeking the Personal Financial Specialist (PFS) credential. Information about the CPA/PFS credential is located at aicpa.org/PFS.