August 2009

What You Need to Know About Social Security

Author: Lew Wessel

You’re closing in on 62, the age at which you can begin to collect on Social Security. It is decision time. Take the check now or wait? What you need to know is that this decision is neither easy nor trivial.

What is Social Security? When you look at your paycheck and start moaning about the 7.65 percent taken out for Social Security, take some solace in the fact that Social Security is more than a pension or life annuity. It is actually a catch-all term for a number of benefits: retired worker’s benefits, spousal benefits, survivor benefits, spouse/caregiver benefits, unmarried child benefits, disability benefits and a nominal death benefit. The “retired worker’s benefit” is normally what we think of when we say “Social Security,” but as will be discussed below, the other benefits are important. I’m going to focus here on essentially post-retirement benefits, but you owe it to yourself to learn at least the basics of the entire OASDI program. Go to www.ssa.gov and spend a few minutes.

Social Security is critical to retirees! Social Security payments represent 42.5 percent of the total income of retirees (36 percent comes from savings and investments and 21.5 percent from employer/employee pension plans). For one third of retirees, the Social Security check is their ONLY income and for two thirds of retirees, it represents 50 percent or more of their income! Even for those who don’t rely heavily on the Social Security check, the amounts are not insignificant. The average Social Security check is $1,153/month and can go as high as $2,323/month at “Normal Retirement Age” (NRA)—currently 66 years old—for top earners. In addition, your check will increase every year with inflation. In order to achieve that level of indexed income for life, one would have to accumulate savings of from $350,000 to $700,000 based on a withdrawal rate of 4 percent per year.

The consequences of taking Social Security at age 62 are significant and permanent. It’s tempting to grab that check as soon as possible, but, before you do, STEP BACK, take a deep breath and consider: The size of one’s check is permanently reduced by 25 percent (e.g. from $1,000 to $750) if you begin to receive the check at 62 as opposed to waiting until your NRA. This early payment penalty will increase to 30 percent for those born in 1960 and later. In addition, since your surviving spouse is entitled to the higher of his/her Social Security check or yours upon your death, the decision to take a reduced check now may have a long-term impact on your spouse’s income as well (see discussion below). Finally, any “earned income” from the date you begin collecting Social Security until reaching the NRA reduces your check by 50 cents on the dollar.

Despite these facts, fully 60 percent of retirees begin collecting Social Security at age 62. For some, this may be the right decision, but for others I believe the choice is ill-considered. This early pay-out decision is often based on a naive “bird-in-the-hand” decision, a lack of appreciation for the impact of the decision and a concern that Social Security may not be around much longer. I personally do not share that concern. Social Security is so critical to retirees that its description as the “third rail” of politics is apt, if not understated. There may indeed be changes to the future funding formula and perhaps a tweaking of the eligibility age and income tax rates for wealthier recipients, but the basic benefits will, in my judgment, remain.
So, recognizing the importance of the decision, how does one go about deciding when to start Social Security?

For single persons, the process is fairly straightforward. If you decide to take your check at 62, this should be coupled with the decision to more or less retire from making “earned income” (income from wages, self-employment, etc.) at least until your NRA, as any earned income over just $14,160 per year will penalize Social Security earning $1 for each $2 earned. Another key factor in your decision-making should be your best guess as to how long you are going to live. The decision is actuarially neutral; i.e. the size of the Social Security check is reduced for those taking it at age 62 so that the total amount over the normal lifespan (about 77.5) will be equal to taking the check at 66 or later. Obviously, if you are in poor health and don’t expect to live into your mid-70s AND you are single, take the check as early as possible. If you come from a long line of centenarians, you probably should wait, as the impact of that reduced check will become more and more painful as you live into your 80s and 90s.

If you are married, the decision as to when to start taking Social Security becomes much more complicated and far-reaching. This is because, by taking a reduced Worker’s Benefit check at 62, you also permanently affect the size of your spouse’s Survivor Benefit. The Survivor’s Benefit, in a nutshell, entitles your spouse to the higher of his/her own current amount or the amount you were getting at the time of your death. If your spouse gets a bigger worker’s benefit check than you do, the Survivor’s Benefit is superfluous as he/she will just continue on with his/her own larger check. However, if he/she were a non-working spouse with no earnings, then the issue becomes very significant. If he/she is considerably younger than you and made significantly less than you, then the issue becomes THE critical element in your decision. Your health and your spouse’s health will also be factors to consider.

How big is this issue? Potentially HUGE: A $2,000/month check that one is entitled to at NRA translates to approximately a $1,500/month check at 62 and $2,600 at age 70. That’s a 70 percent + difference! If a young spouse is involved, this could represent a difference of hundreds of thousands of dollars over a 30-year period.
The most important thing to remember: If you are married, then the Survivor’s Benefit aspect of Social Security requires an analysis of your benefits as not simply an annuity based on your life, but a joint-life annuity based on your and your spouse’s life. With a couple, both aged 65, there is a 50/50 chance one spouse will live till at least age 90; thus, this analysis is critical.

Note to divorcees: If you were married to an ex for 10 years or more, you also may have Social Security rights related to your ex’s earnings. Check out www.ssa.gov to begin your research.

Research, then decide.
The decision to start taking Social Security at age 62 or to wait until 66 or later is not simple or trivial. It depends on a number of factors including marital status, health (both spouses), life expectancy, work situation, disparity of ages and earnings of both spouses and other factors. It is imperative for you to do the proper analysis before making your choice.

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