A Different Look at Spousal Social Security Benefits

With the wave of Baby Boomers reaching Social Security milestone ages each day, more couples are getting confused about the optimal strategy for taking Social Security benefits.  There are some good websites out there that can help you try to maximize the best strategy for your situation.  Additionally, many financial planners and other finance professionals are either well prepared to handle such questions OR they are getting up to speed as quickly as possible.  

The financial press has done a good job of highlighting the two most popular options for you: file and suspend and file for a restricted benefit.

My purpose today is to discuss a strategy that many couples may face.  Can a spouse take their benefit, based on their own earnings, at age 62 and then opt for the spousal benefit at age 66?  If they can, how do you calculate the benefit at each period?   

The first thing that has to be considered is whether or not the spouse is still working?  If they are still working at age 62 and earning more than $14,640 then it likely does not make sense.  This is because Social Security will deduct $1 for every two dollars that you earn in excess of $14,640 in years leading up to your full retirement age (FRA) and will deduct $1 for every $3 earned in excess of $38,880 if you reach your full retirement age this year.

For clarification, the Social Security Administration determines the full retirement age as the year in which you can get your Social Security benefit without it being subject to a reduction.  It happens to be age 66 for individuals born between January 2, 1943 and January 1, 1955. 

Let’s review a scenario that I saw recently where a husband, Jim, and wife, Peggy, are both 62 years old.  Jim is still working but Peggy has effectively retired. 

Options

Peggy has two options with regards to claiming Social Security benefits:  (1) take Social Security benefits based on her own work record or (2) take Social Security benefits based on her spousal benefits which are equal to ½ of Jim’s benefit at his full retirement age (subject to a reduction if she takes them prior to her full retirement age).  Peggy can NOT take spousal benefits until Jim has started his benefits.  Jim is still working and making more than $14,640 so it does NOT make sense for him to start claiming his Social Security benefit merely so Peggy can file for a spousal benefit. 

If Peggy takes her own benefit at age 66 – her full retirement age – she is projected to have a benefit of $8,000/year.  If Peggy opts to take her spousal benefit at age 66 she is projected to have a benefit of $13,500/year.  Remember she can’t take her spousal benefit at age 62 because Jim has not filed for his benefits.  However, she can take her benefits now – at age 62.  If she does so, then the Social Security Administration will reduce her benefit by 25% to $6,000/year. 

Social Security allows each spouse to take the higher of their own benefit or ½ of their spousal benefit.  Theoretically, you are supposed to receive the higher of the two when you file for benefits unless you file a restricted application – which can only be done once you reach your full retirement age.  Filing for a restricted application is a useful strategy that allows you to claim your spousal benefit while delaying your personal benefit (and allowing your personal benefit to continue increasing).   Peggy doesn’t have access to her spousal benefit because Jim has not filed for his benefits yet.  In other words, if Peggy files for benefits now she is only able to receive her benefits of $6,000/year. 

If Peggy files for her benefits now and Jim waits to begin his benefits until age 66 – his full retirement age – what happens to Peggy's benefits at the time that Jim files?  Does she get to step up to her full spousal benefit of $13,500 (adjusted annually for inflation)?  Is she forever locked into her early, reduced benefit of $6,000/year (adjusted annually for inflation)?  The answer is NO to both of the above.  In this particular instance, at age 66, Peggy would receive a step up to a higher benefit, but not her full spousal benefit.  Here is how the calculation would work:

      1)    The Social Security Administration would look at the difference between Peggy’s benefit at her normal retirement age and her spousal benefit at her normal retirement age.  In this instance, Peggy’s benefit at age 66 is $8,000 and her spousal benefit at age 66 would be $13,500 – making the different $5,500. 

      2)    The Social Security Administration would add the difference of $5,500 to her benefits that she initiated at age 62 – which were $6,000/year.  Therefore, at Peggy’s age 66 she will start to receive $11,500/year for the rest of her life.  From age 62 to age 66, she will receive $6,000/year. 

So being able to utilize the spousal benefit in this instance helps increase the wife’s benefit but should she do it?  You can only truly know the best utilization of Social Security benefits after both the husband and wife have passed away. 

The best way to utilize Social Security benefits depends on your life expectancy, your spouse’s life expectancy, the rate of inflation over the coming decades, the rate of return that your money could earn elsewhere, and whether your present situation demands that you need to take your Social Security benefits early.  A good financial planner can help you determine the best and most appropriate way to utilize your Social Security benefits.  

Social Security benefits are an important piece of the retirement equation for many Americans.  With the traditional pension plan fading into distant memory and being replaced by the 401(k), oftentimes Social Security is the only source of steady income that can be anticipated in retirement.  So it is no wonder that people want to make sure that they maximize that income stream.

Let’s quickly discuss a few key aspects of Social Security benefits and two important strategies available to you via the Social Security Administration:

Key Aspects:

      

      1)      Full Retirement Age (FRA) – this is the age where you can begin to receive your full Social Security benefit without being subject to a reduction.  For individuals born between January 2, 1943 and January 1, 1955 the FRA is 66.  If you initiate your benefits prior to age 66 then the Social Security Administration will reduce your benefit by 5/9 of 1% for the first 36 months  (year 66 down to 63) and 5/12 of 1% for the last 12 months (year 63 to 62).  However, if you delay your retirement benefits beyond your FRA to age 70 then you get a monthly increase of 2/3 of 1% - or 8% per year. 

      2)      Spousal benefits –married couples can qualify for the higher of your benefits based on your own work history or ½ of your spouse’s benefit at FRA.   Your spousal benefit is NOT impacted by when your spouse initiates their benefits but it is reduced if you take your spousal benefit prior to your full retirement age. 

For example, let’s assume Ken (65) and Rebecca (62) are contemplating when they want to take their benefits.  IF Ken decides to take his benefit today – at age 65 – he will receive a reduced benefit because his full retirement age is 66, so the SSA will penalize him for starting his benefits early.  However, the fact that Ken started his benefits at age 65 has NO impact on Rebecca’s spousal benefit.  If she waits until her age 66 then she will still receive one-half of Ken’s full retirement benefit – assuming it is higher than Rebecca’s own benefit.  It is worth mentioning that spousal benefits do not increase in value after age 66 so there is no reason to delay spousal benefits beyond age 66. 

      3)      Widower’s benefit – The surviving spouse will receive the higher of their benefit or their deceased spouses benefit.   If Ken has a benefit of $2,000/month and Rebecca has a benefit of $1,500/month Rebecca will receive $2,000/month IF Ken predeceases her.  On the other hand, if Rebecca predeceases Ken he will continue to receive $2,000/month since his benefit is higher. 

      4)      This has been written about a lot but it is worth mentioning again.  Your Social Security benefits are based on an actuarial table – meaning there is a breakeven point for whether “you win” or the “government wins.”  In order to know the best option, you need to know your life expectancy and the rate of return that you can earn on your money if you were to start your benefits early (and since you do NOT know either you can only make an educated guess). 

Under most assumptions, the breakeven is somewhere between ages 78 and 82.   This means that under any strategy where you start your benefits early means “you win” if you don’t live to age 78 (kind of reverse thinking in a world where you win by dying early) and the government wins if you live beyond 78 to 82.  On the other hand, under most strategies if you wait as long as possible, you win if you live beyond age 78 to 82 and the government wins if you die prior to that. 

Important Strategies

      1)      File and Suspend – this is a strategy that allows you to file for your Social Security benefits and then suspend them.  You may do this for any number of reasons.   One reason to do this is to maximize your benefits with your spouse.   The typical strategy would have one spouse file for their benefits at age 66 and immediately suspend them.  This then allows the other spouse to start their spousal benefits.  This strategy is only available once you have attained your Full Retirement Age (FRA).

      2)      File a Restricted Application – the Social Security Administration will automatically pay you the higher of your benefit or ½ of your spouse’s benefit – assuming you are eligible – when you apply.  It is great that they do that because many people do not know the rules governing Social Security benefits.  However, there may be times where you want to intentionally delay the higher paying benefit.  Once again, you can only file a restricted application at your full retirement age (FRA). 

Let’s assume that several years have passed and Ken is now 70 and Rebecca is 66.  Remember that Rebecca’s benefit was $1,500/month at age 66 and Ken’s benefit was $2,000/month at his age 66 – making her spousal benefit equal to $1,000 (50% of $2,000 is $1,000).  Since Ken is already age 70 he has started his Social Security benefits so Rebecca is now eligible for spousal benefits.  But why would she want to elect spousal benefits if her benefit is higher. 

Great question!  Rebecca MAY want to file a restricted application for just her spousal benefits and allow her benefits to continue increasing by 8% per year until her age 70.  This allows Rebecca and Ken to have an additional $1,000/month in income while letting her benefit increase by 8% per year until age 70 – essentially making her $1,500/month benefit at age 66 grow to $2,040/month at age 70. 

It’s important to work with a financial planner who is prepared to discuss these options though.  There are times when the strategy for Rebecca and Ken may not be right for you.  After all, Rebecca gets a step up to Ken’s benefit – which has also been growing – if he predeceases her.  This means that there are now three benefits to take into account when trying to determine the appropriate breakeven strategies.  Financial Planners who deal with these questions on a regular basis are likely to have some insight that is important in your decision making process.