The Social Security Act was written into law in 1935 as part of President Franklin D. Roosevelt’s New Deal. It is primarily funded through payroll taxes enacted in the Federal Insurance Contribution Act (FICA). Part of this is funded by the employer and part by the employee, with each paying 7.65% of the first $113,700 of earned income. The tax collection did not begin until 1937 and the first monthly check was issued in 1940. The first recipient was Ida May Fuller of Vermont in 1940. She paid in a total of $24.75 during 1937, 1938, and 1939 before receiving her first monthly payment of $22.54. In the 1930s the life expectancy for a woman was 62. Ida May lived until she was 100 collecting a total of $23,000 in benefits.
Longevity is a good problem to have. However, running out of income in retirement is one of the greatest fears of retirees today. This is why it is crucial to understand life expectancies when deciding how and when to start receiving Social Security benefits. According to the authors of It’s Your Money (Simple Strategies to Maximize Your Social Security Income), John and Angela Deppe, there is a 50% chance that at least one spouse of a 65 year old married couple will live until age 92, and a 25% chance that one will live to age 97. When married couples are planning to retire it is important not only to look at the financial needs today but also the surviving spouses needs. Before I lay out a couple scenarios to better explain, we must address a few terms and facts.
Important Terms:
Full Retirement Age (FRA) – is the age at which the full Primary Insurance Amount can be received. This was originally 65 but has been gradually increased to 67 depending on year of birth. For Birth years 1960 or later it is now 67.
Primary Insurance Amount (PIA / Individual Benefit) - is the monthly amount received if a recipient waits until Full Retirement Age to begin receiving benefits. If the benefit is taken before FRA the amount is reduced (see chart below).
Average Indexed Monthly Earnings (AIME) -is calculated by taking the average of the highest 35 years of earnings. This is then divided by 420 (35 x 12months). Each year is indexed for inflation so it can be equal to today's dollars. If an individual has not worked for 35 years then a $0 input is added where necessary and factored into their AIME calculation.
Federal Insurance Contributions Act (FICA) – requires employees and employers to pay into the Social Security system. Employees contribute 7.65% of their first $113,700 of earned income (6.2% social security and 1.45% to Medicare). The employer also pays 7.65% of the employee’s first $113,700 of earning. When FICA taxes are paid, ‘credits’ are awarded toward Social Security benefit eligibility. To earn a credit, income must be at least $1160 (in 2013). Up to 4 credits can be earned per year. To be deemed fully insured, or eligible for Social Security benefits, 40 credits (approximately 10 years) must be earned.
Cost Of Living Adjustment- is the adjustment made to the reported Social Security Benefits estimation in order to account for inflation.
Delayed Retirement Credit (DRC) - is an increase or bonus received for waiting past FRA to begin receiving Social Security. Up to 8% per year can be added to the monthly benefits for every month after FRA that an individual waits to take their social security. This is in addition to the cost of living adjustment. Recipients must begin taking a benefit at age 70.
Individual Benefit– is the Primary Insurance Amount that you can receive at Full Retirement Age based on your earned income. A reduced amount can be received as early as 62.
Spousal Benefit / Ex-Spousal Benefit– is the benefit a spouse may receive based on the earned income of their partner. To be eligible for the Spousal or Ex-Spousal Benefits an applicant must be one of the following:
If these criteria are met, the Spousal Benefit can be as much as 50% of the Primary Insurance Amount, depending on spouse’s age when applying for the benefit.
Survivor Benefits- are monthly benefits a surviving spouse may receive based on the deceased individual’s earnings history. Recipients do not have to be eligible for their own benefit. A widow / widower must be at least age 60 and married for at least 9 months. The survivor will receive a reduced amount if taken before their Full Retirement Age (see chart below). Survivorship benefits do not receive Delayed Retirement Credits like an individually earned social security benefit would. Therefore, there is no benefit to wait beyond Full Retirement Age to collect a survivor benefit.
To better understand these terms and how benefits are calculated let’s look at an example from the book It’s Your Money! by John and Angela Deppe.
In this example, Tom and Cindy are both 62. Cindy left the workforce for a period of time to raise their children. Tom’s Primary Insurance Amount (PIA) at Full Retirement Age (FRA) of 66 is $2,000 per month and Cindy’s is $700 per month. Based on the mortality tables and longevity discussed earlier let’s assume that Tom lives until age 80 and Cindy lives until age 92.
If Cindy Takes the Spousal Benefit instead of her own
Tom can collect early but will receive a reduction of his Primary Insurance Amount. If he chooses to take his benefit early and decides to continue to work he may be penalized if his income is over certain thresholds. If he is under his Full Retirement Age and earns more than $15,120 (2013 limit) then his Social Security Administration (SSA) will reduce or withhold $1 of his benefit for every $2 he earns above this amount. For the year that he reaches his Full Retirement Year the SSA will withhold $1 for every $3 of earnings above $40,080 (2013).
You may withdraw your request to collect monthly Social Security benefits within the first year of filing for benefits. In Tom’s case, if he decided to go back to work he could suspend his benefit. However, he would have to pay back any benefit that he had received up to that point.
Cindy can take the greater of her individual benefit or the spousal benefit. The spousal benefit is always calculated off of the higher earning spouse’s PIA. If she takes the benefit early, then the spousal benefit (the difference in her benefit and 50% of Tom’s benefit) is reduced at a different rate then the individual benefit, as seen above. The spousal benefit does not get the Delayed Retirement Credit (the increase after reaching Full Retirement Age).
As you can see from the chart (right), in this case the ideal strategy would be for both Tom and Cindy to wait until age 70 to begin collecting benefits. Utilizing this strategy Tom and Cindy would collect $816,960 in benefits, almost $25,000 dollars more than any other collection strategy.
This is a very simple example, but in many cases strategies that maximize a couple’s benefits can be very complicated. When trying to maximize a couple’s social security benefits, the decision of when to claim should be made together. In general, the age at which the higher earning spouse should claim his/her Social Security benefit is based on the life expectancy of the lower earning spouse. Conversely, the age at which the lower earning spouse should claim his/her benefit is based on the life expectancy of the higher earning spouse.
Careful planning should factor in variables such as longevity, other sources of income, benefit amounts, and age differences. Although charts such as the one above for Tom and Cindy can help maximize the benefits received from Social Security, they cannot take into account the effects deferring benefits can have on the level of other assets. To develop a full retirement and benefits strategy it is best to lay out a comprehensive financial picture to account for all variables. For more information or to schedule a meeting to discuss your specific situation please call 888-389-6339 or email joe@globalviewinv.com