Saturday, December 12, 2009

Taking Social Security Seriously

A Key Decision for Retirement Planning

Most people who are younger than age 62 do not take Social Security seriously. For decades, the media has hammered into people that Social Security is going bankrupt and they cannot depend on it for retirement. Changes in the program will be necessary to keep it solvent but that has happened in the past and will likely happen again. The most recent major reforms occurred in 1983 and changes are needed again as life expectancies increase and major changes occur in Americans’ work habits.

Still, each year the Social Security Administration sends out more than $600 billion in benefits and nearly all Americans depend on the payments as one of their top four assets in retirement. Understanding the program is vitally important for most people.

One of the most important decisions people make about retirement is when to begin receiving Social Security benefits. And yet many people either do little analysis or only simple calculations. Delaying benefits can sometimes result in doubling monthly payments so it’s worth spending time on the decision. Many current retirees will collect more than $1 million in benefits from Social Security.

Ideally, Social Security should be part of your total retirement planning and should begin 10 to 15 years before full retirement age, now 66. Benefits are based on reported income during your top 35 working years. The formula is skewed toward average wage earners so people in their 50s can still influence benefits. In some cases people might want to take part-time jobs or even decline to use deductions and pay more taxes to maximize future benefits.

To the extent people analyze the decision, most use a simple break-even analysis that calculates when the higher payments received at a later age would surpass the smaller payments received for more years. This analysis ignores many factors and it’s potentially misleading. Frequently, people using this analysis underestimate their life expectancy. One quarter of the people who start Social Security at full retirement age will live into their 90s. A mistaken analysis will cost them dearly for decades.

The critical ages for influencing Social Security benefits are the decades of the 50s and 60s. By age 70, everything will be cast in stone. The Social Security formula is skewed toward modest earners, so people in their 50s can still greatly affect their Social Security benefits. Self employed professionals and spouses who left the workforce to raise children are among those who could benefit most from an analysis.

The analysis is complicated for one person but it is much more complicated for a couple, particularly when the ages and earnings histories diverge. Other factors to take into account are that benefits are cut between ages 62 and 66 if the person continues to work; one spouse can receive half the benefits of the other upon reaching full retirement age; and a survivor receives the highest benefits of either spouse. Social Security benefits are also taxed once the retiree reports income above a certain threshold. Those taxes now begin on couples with incomes about $32,000 and as much as 85 percent of the benefits are subject to taxation if their combined income is more than $44,000.

Each person or couple’s situation is unique but a proper analysis of when to apply for Social Security benefits should weigh at least 13 factors: age of each spouse, health, family history, joint life expectancy, previous marriages, current and future spending, retirement plans, tax bracket, reduction in benefits if they work before full retirement age, current assets, future sources of income such as pensions or inheritances, and life insurance. The Social Security website, www.socialsecurity.gov, provides a wealth of information and calculators where one can access his own earning history, but no one source of analysis takes everything into account. An accountant or financial advisor should be able to calculate different scenarios and advise on the risks and advantages of each. It is a complicated topic; long academic papers are being written on the subject.

In all cases it pays to begin taking your own benefits by 70 or spousal benefits at full retirement age. If you receive retirement benefits early, between 62 and 66 now, the benefits are permanently reduced by as much as 35 percent depending on year of birth. Between 66 and 70, your own benefits increase by 8 percent a year. Spousal benefits, which are a maximum of 50 percent of the higher earning spouse’s, cannot increase past full retirement age. However, survivor benefits do increase. Once the higher earning spouse dies, the survivor receives benefits equal to those of the higher earning spouse so it’s important to take joint life expectancies into account.

It’s not uncommon for people today to underestimate their life expectancy and outlive their assets. This is particularly important for women, who on average outlive their spouses and will end up relying on one Social Security check in their later years. Getting the best possible answers on Social Security could make a big difference in the comfort of one’s retirement.