By James Lange, CPA
For many people, emotions might win out over objectivity when it comes to applying for Social Security benefits. The rationale that I often hear from people who want to apply for Social Security at age 62 usually is: “I’ve paid into the system for decades and I might as well get something out of it before it goes bankrupt.” While that might feel like the best option, it could be the worst. It’s all in the numbers. And learning how to evaluate the numbers is not too complicated, but it could be the most important “numbers game” you will play.
There are significant financial repercussions for applying for Social Security at age 62, the earliest age at which you can start receiving benefits. For example, if you were born prior to 1954, the penalty for applying at 62 is a whopping 30%. If the benefit amount you would be entitled to receive at your full retirement age (FRA), age 66, is $2,000, by applying at age 62 you will only get $1,400. If you wait until you are age 70 to begin tapping into Social Security— four years past your FRA—you will have earned an additional 8% increase for every year you wait. That will bring your monthly check-up to $2,640. The difference almost doubles your income from Social Security, every month for the rest of your life. That is not a hard number to understand, nor is it a difficult calculation.
Consider the implications if you live a long life…which is the critical variable.
The “break-even” point shows that if you live until age 82 you will have received the same amount of income from your benefits as you would have if you had applied at age 62. So, if you apply at 62 and then die before age 82, you win, right? Well, you break even. It’s not a win or a loss. The loss comes if you live on...The long-term planning fear is not that you might die early and miss out on some money you could have had, but rather that you will outlive your money. Waiting to collect Social Security is a form of longevity insurance—for you and also for your surviving spouse if you are the higher wage earner.
For married couples, the decision about when to apply for Social Security is even more critical, especially for couples who have an income disparity. For the lower wage earner, your benefit will be based on your own earnings record or on your spouse’s earnings record, whichever is higher. That is to say, if your spouse has earned more than you for many years you can receive a better benefit than you can receive from your own earnings record (if you have one at all). The maximum spousal benefit you can receive while your spouse is living is 50% of their benefit at FRA. If you are receiving a spousal benefit and your spouse dies before you, your smaller spousal benefit will stop, and you’ll begin to receive an amount equal to your spouse’s full benefit. That’s why it’s so important that the higher earner wait for as long as possible to apply for Social Security benefits.
Historically, men have earned more than women in most of the households that are weighing their Social Security options now. A woman’s life expectancy is about five years longer than males of the same age. If you married a man who is older than you, then chances are if you are a woman (or have really good genes) you will outlive your husband by even more years. The higher-earning spouse who waits to apply for Social Security until age 70, guarantees themself a higher benefit and guarantees their surviving spouse a higher benefit for the rest of the spouse’s life, too.
Waiting to apply for Social Security benefits has the potential to open a window of opportunity for Roth IRA conversions at a low tax rate. If you are working now and plan to retire at age 66 but you hold off on Social Security until age 70, you will have four years when you don’t have taxable income from wages, Social Security, or required minimum distributions from your IRAs—that can put you in a lower tax bracket. Making a series of Roth IRA conversions between the time that you retire and age 70 could make an enormous difference in your retirement plan.
Taking a long-term perspective is critically important. Don’t be in a hurry to tap into Social Security until you have considered all the implications to your lifestyle not only while you are both alive, but also after the first spouse dies. This is especially true if you don’t have a lot of savings and will be relying on Social Security to provide a large portion of your income. While it may be tempting to take the money and run at age 62 that impetuous decision could compromise your long-term security and comfort.
Naturally, each person’s circumstances will be different and there may be other factors that influence your decisions. But I highly recommend that you plan your Social Security decisions so that they make sense for both you and your spouse!
About the Author: James Lange
James Lange, CPA/Attorney, is a nationally recognized IRA, 401(k), and retirement plan distribution expert. Lange is the author of several best-selling books that help IRA and retirement plan owners to get the most from their retirement plans using Roth IRA conversions and tax-smart planning as an integral part of the planning strategy. For more information, visit www.PayTaxesLater.com.
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