Wednesday, March 04, 2015 |
Joe Alfonso, GoLocalPDX Contributor
Most of us are aware that Social Security is at its core a retirement program whose purpose is to replace a portion of our career earnings once we are no longer working. In addition to retirement benefits, Social Security also provides benefits for the surviving spouse in a marriage. In this regard, Social Security acts as a form of life insurance by ensuring that the surviving spouse receives a lifetime income payment based on the work record of the higher earning spouse in the marriage.
The rules governing survivor benefits differ from those governing Social Security retirement and spousal benefits. These differences present special planning opportunities for surviving spouses who are also eligible for their own retirement benefit.
I was recently reminded of the unique planning opportunities made possible by survivor benefits while working with a client, whom I will call John. John is 65 years old and still working. He was married to a woman 15 years younger than him who unexpectedly died two years ago at the age of 48. John qualifies to receive a retirement benefit based on his work history. As a result of the death of his wife, he is also eligible for a survivor benefit. John asked my help in deciding how to coordinate his benefits in order to maximize his lifetime Social Security income.
In analyzing John’s situation I learned that his projected retirement benefit starting at his full retirement age (FRA) of 66 is approximately $2,150. In comparison, his projected survivor benefit at FRA is $2,340. John plans to continue working indefinitely and estimates annual earnings of about $80,000. He is in good health.
I analyzed John’s claiming options in light of the following key considerations:
1. Taking either a retirement benefit or the survivor benefit before FRA results in a benefit reduction
2. Delaying retirement benefits past FRA results in an 8% annual credit until age 70. In John’s case, delaying to age 70 would result in a 32% benefit increase compared to the FRA benefit, making his age 70 benefit worth approximately $3,130 (before inflation adjustments, known as COLAs).
3. Survivor benefits do not receive delayed credits so there is no benefit to delaying these beyond FRA
4. Unlike in the case of spousal and retirement benefits, where a decision to claim either benefit before FRA also results in a reduction of the other, survivor benefits are immune from other benefit claiming decisions, and vice versa. One can therefore claim a spousal or retirement benefit early and still receive a full survivor benefit as long as the survivor benefit is claimed at FRA. Conversely, it is possible to claim an early survivor benefit and then switch to a full retirement or spousal benefit at FRA.
5. Any benefits claimed before FRA, while earning employment income in excess of an annual maximum, results in a withholding of benefits. In 2015, the “Earnings Test” wage limit is $15,720; for every $2 earned in excess of the limit, $1 of Social Security benefits are withheld. The Earnings Test does not apply once FRA is achieved.
The best strategy to follow when “dually entitled” to a retirement and a survivor benefit is to take the higher benefit last, factoring in the fact that retirement benefits earn delayed credits while survivor benefits do not.
In John’s case, if he had not been working and therefore not subject to the Earnings Test, his optimal strategy would be to claim a reduced survivors benefit immediately and defer taking the retirement benefit until age 70. While the survivor benefit would be reduced for early claiming (by 4.5%) to about $2,240, by waiting to claim his retirement benefit to age 70 he will have maximized it and thereby ensure that he will earn the maximum cumulative income over the course of his life.
By not waiting to FRA to claim the survivor benefit, he would earn an additional year of income that more than offsets the impact of the resulting benefit reduction. He would continue to collect the reduced survivors benefit until age 70, at which time he would switch to his retirement benefit, which by then would have grown to $3,130.
The fact that a decision to claim the survivor benefit early does not result in a reduction of his retirement benefit makes this the optimal strategy. It also illustrates how the decoupling of the respective claiming decisions in the case of survivor benefits makes creative planning possible.
Of course, John is in fact working and earning well in excess of the Earnings Test limit. This means that it does not makes sense for him to claim early benefits since they will be withheld in their entirety.
John’s optimal claiming strategy therefore, given his specific situation, is to claim an unreduced survivor benefit of $2,340 at his FRA and delay his own retirement benefit to age 70. Since he will be past FRA, the Earnings Test will not apply and none of his survivor benefits will be withheld. By claiming the survivor benefit at FRA he is guaranteed to receive the maximum benefit possible. And by delaying his retirement benefit until age 70 it will grow to $3,130 as a result of delayed credits. The net result of this strategy is that John will earn the highest lifetime cumulative income to which he is entitled.
My calculations, assuming a 2% annual COLA, showed that the cumulative income through age 85 yielded by the combined survivor and delayed retirement benefit would total $818,000. In comparison, the cumulative income for just the retirement benefit would be $638,000, assuming it was claimed at FRA. Cumulative income would be $700,000 if the retirement benefit was delayed to age 70.
Clearly the survivor benefit makes a huge difference in John’s case. While the loss of his wife at such a young age was certainly tragic, this sad event results in a valuable legacy to John that will benefit him for the rest of his life.
A version of this article originally appeared in the Business Section of GoLocalPDX