The recently enacted Bipartisan Budget Act of 2015 is a popular topic among financial planners these days. This is particularly true because in 2016 it will eliminate two options married couples have been using to maximize Social Security benefits.
The first option, commonly called “file and suspend,” allowed a person who earns less money than their spouse to claim a spousal benefit while the higher-earning spouse’s benefit continued to grow until that spouse reached age 70. The second option, commonly referred to as a “restricted application,” allowed a higher-earning spouse to restrict their application for benefits and enjoy a spousal benefit while his or her own benefit continued to grow until age 70. Both of these planning options have been deemed “loopholes,” and they are now prohibited, with some brief transition periods that close this year.
Many articles have been written about the loss of planning opportunities for future retirees. Maybe what’s more important than describing the now-forbidden loopholes is considering planning options that remain for the vast majority of future Social Security beneficiaries.
Although each couple’s situation is unique, one way to approach analyzing the remaining Social Security planning options is to consider a same-aged married couple under two different scenarios. In Scenario 1, the lower-earning spouse expects a Social Security benefit greater than half of the higher-earning spouse’s projected Social Security benefit. In Scenario 2, the lower-earning spouse expects a Social Security benefit less than half of that of the higher-earning spouse.
Benefits Scenario 1
When the lower-earning person has a projected Social Security benefit greater than half of their higher-earning spouse’s benefit, the spousal benefit will not be of interest to the lower earner because their own benefit will be greater. The question then becomes, “When do you turn on both benefits to maximize the amount of Social Security payments the couple receives?”
The answer depends on the ages and health of the spouses. A Social Security recipient can increase the benefit payment by delaying the starting date from age 62 to either the full retirement age (the FRA), which is between 66 and 67, depending on your year of birth, or age 70 (the maximum starting age).
Assuming a healthy 65-year-old couple, there is a 60 percent chance that one of them will live to age 90. The general view is that the delayed benefit pays more if the beneficiary lives to at least age 83. So the better choice might be to delay the larger benefit to age 70 to allow that benefit to grow and possibly provide a richer surviving spousal benefit to the lower-earning spouse.
What about the lower-earning spouse’s benefit? One reasonable approach would be to start the lower earner’s benefit earlier, say at age 62, because there is less than a 50 percent chance that both spouses will live past age 81. Of course, if you have the means to live without Social Security and if both spouses are in good health and have families with longevity, then you can maximize the longevity protection embedded in Social Security by delaying the lower-earning spouse’s benefit to the FRA, or to age 70.
Benefits Scenario 2
If the lower earner has a Social Security benefit that is less than 50 percent of their higher-earning spouse’s benefits, the spousal benefit of the higher earner will be especially valuable to the lower-earning spouse. Under the new rules, the only way to start that benefit for the lower-earning spouse is for the higher earner to apply for their own benefit payment.
Given that the spousal benefit stops growing at the FRA, a couple in this situation may reasonably decide to wait until reaching the FRA to start both the spousal benefit and the higher-earning spouse’s benefit. This means, unfortunately, that the higher-earning spouse’s benefit will not grow between the FRA and age 70. But it does start the spousal benefit when it has reached its maximum value. If this couple feels good about their health and combined longevity, then it still may make sense for them to delay both benefits until they reach age 70.
The above scenarios are just a starting point for analyzing your clients’ own circumstances. For example, you may need a different analysis under both scenarios if the spouses are different ages.
These strategies focus on taking longevity probability into consideration when planning how to maximize Social Security benefits. However, there’s a compelling argument that the most important feature of Social Security is how it can help your clients better ensure they will not outlive their assets. This perspective puts greater emphasis on delaying Social Security benefits so that your clients have the greatest possible payout, without regard to whether they get back some or all of their contributions.
If your clients value longevity protection, the general rule always should be to wait until age 70 to start benefits (with possible exceptions for those who are the least healthy). Although this may leave some economic value on the table in some circumstances, it does provide your clients with the greatest protection should they live longer than expected.
Changes Mean a Reduction in Benefits for Most
The bottom line regarding these changes is a reduction in Social Security benefits for most future beneficiaries. These changes, like the previous FRA increase from age 65 to age 67, reduce the overall value of Social Security. Moreover, future reductions in the value of Social Security — whether in the form of a reduced cost-of-living adjustment, increased payroll taxes or a reduction in benefit payments — have been proposed as a means for addressing the Social Security solvency issues.
The changes already enacted to Social Security and the possible future changes to Social Security suggest two actions that your preretired clients should take. First, place a greater emphasis on non-Social Security solutions to retirement planning, such as increasing the savings in their 401(k) and individual retirement accounts and considering annuity solutions to manage their longevity risk. Second, place a continued focus on maximizing Social Security benefits, which will still be the single largest source of retirement income for many individuals.