Q&A: Navigating the Social Security Puzzle

Navigating Social Security benefits can be daunting and complicated due to the relatively opaque nature of the system. If you have received earnings subject to Social Security taxes for at least 10 years, you may want to start putting together your benefit’s puzzle pieces. Understanding the tradeoffs associated with various withdrawal strategies is an important part of creating a successful income replacement program post-employment.

This Q&A outlines some of the key factors when seeking to maximize your overall benefit.

Q: When am I eligible to receive benefits and how is my monthly amount determined?

A: The amount of monthly Social Security income, or the benefit, is calculated based on the highest 35 years of employment income, and is known as the Primary Insurance Amount (PIA). The PIA is reached when one achieves Full Retirement Age (FRA). The Social Security Administration has been increasing the definition of FRA incrementally over time. FRA is 66 for those born in 1954 or earlier; between 66 and 67 for those born between 1955 and 1959; and 67 for those born in or after 1960.

To receive the full benefit amount, filers must wait until FRA to claim the benefit. However retirees may begin receiving benefits as early as age 62 or as late as age 70. The PIA either shrinks or grows relative to FRA based on how early or late one claims the benefit relative to FRA. An early benefit comes with an approximate 6 percent discount to PIA for each year of advanced receipt, while delaying past FRA increases the PIA by approximately 8 percent for each year of delayed receipt. There is a clear monetary incentive for those able to delay their benefit until age 70.

Q: Why, then, would one not delay filing until age 70?

A: Choosing to delay is a classic “time value of money” dilemma. Assume one has reached FRA and, not needing additional current income, has elected to delay receiving benefits until age 70. While the benefit amount is growing, he or she is foregoing income that could be invested, or used for living expenses to avoid drawing from an investment portfolio. The tradeoff largely rests on a question of longevity. The longer the retiree is expected to live, the longer he or she will receive the increased benefit. The expectation of returns on an investment portfolio also influences the decision. The lower the return environment, the more valuable the delayed receipt is at an 8 percent growth rate. Inflation also plays a part as Social Security payments ordinarily receive annual cost-of-living adjustments, making delayed receipt all the more attractive. In all, one would likely not delay filing if they are in need of the current income, life expectancy is below average, or they have high return expectations for an investment portfolio.

Q: How does the delay strategy affect the spousal and survivor benefit?

A: Spouses are entitled to either a benefit equal to 50 percent of their partner’s PIA (“spousal benefits”), or their own benefit based on their employment history, whichever is greater. Spousal benefits and individual benefits are not additive; one or the other must be chosen. The spouse who elects for spousal benefits can begin receiving the benefit when they have reached FRA (or at age 62 with similarly discounted benefits as shown previously) and the primary beneficiary has begun claiming benefits. For spousal benefits there is no benefit to waiting beyond the FRA, as there are no delayed retirement credits as there are for a primary beneficiary. After the primary beneficiary passes away, the surviving spouse who has been receiving spousal benefits becomes eligible for a survivor benefit equal to the primary beneficiary’s benefit. Generally, a delaying strategy for the primary workers makes sense if either they or their spouse will survive to the breakeven point. If both spouses receive their own benefits and do not receive a spousal benefit, however, it may only make sense for both to delay until age 70 if there is a reasonable expectation that both will surpass the breakeven point.

Properly identifying a strategy based on your family’s unique circumstances is the best way to maximize the probability of receiving the largest overall benefit from the Social Security system. Couples need to coordinate the timing of withdrawals based on their life expectancy, the spousal, and survivor benefits, and their overall investment picture. In the end, putting together the Social Security puzzle pieces and carefully establishing a plan can provide the best outcome. Please reach out to your consultant with any questions or concerns regarding your Social Security benefit.

Christian O’Dwyer, CFA is the vice president of Innovest Portfolio Solutions.