A wrinkle in the timeline
In 1983, there was a big concern that the government income replacement plan (social security) would not have enough money to continue paying out benefits. In fact, they were literally months away from the Social Security Trust running out of money. Sound familiar? Many people still believe social security will not be there when it’s their turn to collect, and if it is, there won’t be much left. So, what did they do in 1983 to prevent the system from failing, and can anything be done about it today? We’ll get to that, but first, let’s go over some basics.
How is social security funded?
If you receive a paycheck, there’s a line item for a social security tax of 6.2%. Your employer pays a matching 6.2% for a total of 12.4% that’s contributed to social security from every paycheck. If you’re self-employed, you pay the entire 12.4% yourself. That tax revenue goes to the Social Security Administration (SSA), which distributes cash benefits to those currently collecting social security, and deposits the rest into the Social Security Trust (where it’s mostly invested in treasury bills). So, if you’re working like me, you’re paying for the benefits of your parents, grandparents, in-laws and anyone else currently collecting social security. And they’re always sure to remind me, “Keep working son, so I don’t have to.”
For high earners, you may have noticed that income over a certain point does not have social security tax taken out. That’s because there’s a cap – for 2022 it’s $147,000. Enjoy it while it lasts!
How are social security benefits calculated?
It used to be that everyone earning taxable income would get a social security statement mailed to them once a year. It was the largest annual mailing undertaken by the US postal service. Today, only those 60 or older who have not gone digital still receive physical statements in the mail. For everyone else, we have to sign up online. And if you haven’t signed up yet, we highly recommend it – just visit ssa.gov and take five minutes to create your account. Once you have, you can view your entire earnings history, which you’ll want to double check, because your future social security benefit will be based on the average annual earnings of your top 35 years.
When should you claim?
Now, let’s say you’ve put in 35+ great years, you’re getting ready to retire, and you learn that you can start drawing benefits at age 62. Awesome! It’s your money, you worked hard for it, and you’re entitled to it. While you’re right on all accounts, let’s pump the breaks a bit before making that decision.
You’re allowed to claim your social security benefit at any age between 62 and 70. So the question everyone asks us is, when should I take it? That’s the million-dollar question. The answer is quite simple. In fact, I can tell you the EXACT day you should start drawing social security to optimize your benefits if you can tell me the exact day you’re going to pass away. Because that’s what it comes down to, your longevity.
Your social security benefit grows 8% each year you can delay
In general, if you’re in poor health, and are unlikely to make it past the age of 78, it typically makes sense to take your benefit early, at age 62. If you’re in good health and have a healthy family history, you’re most likely going to want to delay as long as possible, ideally to age 70. Every year you can delay, your benefit increases by 8%. In 2022, full retirement age (FRA) is age 67. Meaning that if you begin drawing at age 67, you’ll get 100% of your benefit. If you were to start drawing benefits early, say at age 62, you’d be penalized 8% a year for five years, and would get about 60% of your maximum benefit. On the other hand, if you can delay until you’re 70, you’ll receive 132% of your benefit!
Social security also calculates COLA (cost of living adjustment) each year. In 2022, COLA added 5.9% to all social security benefits across the board to account for inflation.
If you really can’t wait until 70, then you’ll want to wait at least until your FRA. This age is also adjusted periodically, but for anyone born in 1960 or later, FRA is age 67. To illustrate how great the impact of waiting can be, see the graph below. Here we have a 60-year-old couple trying to decide if they should claim at age 62, 67 or wait until 70, based on a life expectancy of 98. The results are staggering!
By having the lower income earning spouse start to collect at age 67 (FRA) and the higher earning spouse start to collect at age 70, they end up with almost $800K more than if they both took their social security benefit early, at age 62.
Another factor to consider if you’re married or divorced is your spouse. Take the same scenario above. The husband was an engineer earning a decent income for most of his life while his wife stayed home and raised the children. When it comes to the husband claiming social security, he will delay and claim at the age of 70. But what about his wife who worked 10 times harder, but had no taxable income to report? Good news! A non-working spouse will receive 50% of the working spouse’s social security when they claim. So, if the husband received $4,000/month, his wife would receive $2,000/month, even though she had no taxable income. That would bring their monthly social security benefit to $6,000. This $6,000/month will likely play an important role in their financial plan, and help determine how much additional income they’d need from their savings, retirement and other investment accounts.
Now, if one spouse passed away, the surviving spouse would get the higher of the two social security benefits. In this example, if the husband were to pass first, his wife would receive his full $4,000 benefit.
For a couple who had been married for 10 years and got divorced, but did not remarry, the lower-earning spouse would still be eligible to receive 50% of their ex-spouse’s social security benefit, starting as early as age 62.
Younger spouse full retirement age strategy
There’s another claiming strategy you can employ if you’re younger than your spouse. Let’s say your spouse is 68 and you’re 67, and your spouse’s benefit is $4,000/month at age 70, and your benefit is $1,000/month at FRA. You can claim your FRA benefit of $1,000/month at 67, and when your spouse turns 70 and claims his benefit, your benefit will switch to 50% of your spouse’s benefit – in this example, $2,000/month. That would mean that you just got an extra $24,000 over the first 2 years ($1,000/month over 24 months) and increased your benefit to $2,000/month thereafter. Not too shabby.
Will social security run out?
So, how did the social security problem of 1983 get resolved? The Social Security Administration simply increased the full retirement age from 65 to 67, which made the program solvent for the next 50 years. As of today, the Social Security Trust Fund is set to run out of money in 2034. If it does, it’s projected that there still be enough money coming into the system to keep it funded at 78%. But if we’ve learned anything from history, it wouldn’t be surprising if the SSA got together a few months before the Trust ran out of money and either changed the FRA again, or raised the income cap to keep it funded for another 50 years. Given what we know, I’m not worried, and you shouldn’t be either.
As you can see, there are a plethora of considerations to factor in when settling on your social security claiming strategy. And there are plenty of others I didn’t have time to get into here. But social security is a massive benefit, and plays a big role in replacing income in retirement, so it’s a good idea to consult with a fiduciary financial advisor before you claim your benefit to ensure it’s optimized for your financial plan.
If you’d like to discuss your social security claiming strategy with one of our fiduciary financial advisers, schedule a free consultation using the button below.