Social Security: 7 Crucial Mistakes & How to Avoid Them
Bad Social Security advice and poor claiming strategies continue to cost retirees, especially those eligible for spousal, survivor, and divorced retirement benefits.
Social Security has provided benefits to Americans for over 80 years and is a pillar of retirement in the US. However, despite its importance, Social Security is still massively misunderstood. In fact, a report from the agency’s Office of the Inspector General found that bad Social Security advice cost claimants $131 million. Ouch!
Social Security should be viewed as a retirement tool, no different than your IRAs, 401(k), and other assets. The difference between the right and wrong filing decision could be hundreds of thousands of dollars over your lifetime.
Before we jump into the seven mistakes you’ll want to avoid, you need to know some of the basic terms of the Social Security program. These terms include primary insurance amount (PIA), full retirement age (FRA), and cost of living adjustment (COLA).
The PIA refers to the benefit a person would receive if they begin receiving retirement benefits at full retirement age. Oddly enough, the Social Security Administration defines full retirement age as the age at which retirement benefits are equal to your primary insurance amount (nothing like a bit of circular logic to muddy the waters).
Ultimately, your full retirement age varies between 65 and 67, depending on your year of birth. For those born in 1960 or later, full retirement at is 67.
Last but not least, the Social Security COLA refers to increases in benefits due to inflation in the CPI-W index. Cost of living adjustments are not guaranteed but do help increase the amount of Social Security benefits over time. The Social Security COLA for 2021 was 1.3%.
Now that we’ve covered the basics, let’s jump into the seven Social Security mistakes you’ll want to avoid.
1. Ignoring Your Earnings Record
For those that plan to file for benefits based on their own working record (and not use a spousal benefit), your recorded earnings are ultimately what will determine your Social Security benefit. Each year’s earnings on which Social Security taxes were paid are tallied and an index factor is applied.
After each year is indexed, the highest 35 years of earnings are totaled and divided by 420 (the number of months in 35 years). The result is your AIME, or average indexed monthly earnings, which is then applied to a formula.
Therefore, to increase your benefit, you need to increase your earnings. The first mistake resulting from ignoring your earnings record is simply not achieving a full 35 years of earnings. If you can replace a year of $0 earnings with a year of actual earnings, it could result in a meaningful increase in your benefit.
While working another year or two may not be in the cards, working a few months into the next year vs. retiring on December 31 could also cause benefits to increase.
Also, you’ll want to ensure that your earnings record is simply…correct. Mistakes have happened and you don’t want your lifetime Social Security benefit to be calculated on an incorrect earnings record.
Business Owners and Social Security Benefits
A common earnings record mistake made by business owners is simply not paying themselves enough W2 wages during their career. A reasonable salary is typically required for owners, and salaries are subject to FICA taxes (Medicare and Social Security taxes). However, when there is extra income, shareholders may receive additional distributions that are not subject to FICA taxes.
Keeping W2 wages low (and shareholder distributions high) is a strategy used to reduce FICA taxes as much as possible. However, reducing Social Security taxes now will have the negative impact of reducing your Social Security benefits later. Business owners should take long-term Social Security benefits into account when deciding their own W2 wages.
2. Starting Benefits Too Early
While full retirement benefits can be taken at one’s full retirement age, early retirement benefits can be taken as early as age 62, but at a hefty cost. For each year you begin taking benefits prior to your full retirement age, benefits are permanently reduced. Assuming a full retirement age of 67, there is a 30% reduction in benefits if taken at 62 vs. 67. See below.
Exhibit 1: Taking Benefits Early vs. Later
In other words, taking a smaller benefit early will keep you from receiving a larger benefit later. The breakeven age depends on certain assumptions made (like inflation and real return), but typically occurs around 78-79 when comparing filing at 62 vs. FRA. This means that if you live beyond age 79, it would better to delay benefits vs. starting at age 62.
While nobody knows exactly how long we’ll live, it’s important to note that the average life expectancy of a 65-year-old male is around 84.1 years old, and it’s 86.6 for a 65-year-old female.
Taking Benefits Early Can Trigger the Earnings Test
Another reason to avoid taking benefits early is because of something known as the earnings test. For those that start receiving benefits while still working and prior to FRA, the earnings test causes $1 in benefits to be withheld for every $2 earned over $18,960 (in 2021).
In the year you hit your FRA, the earnings test becomes a bit more friendly, with $1 of benefits being withheld for every $3 earned over $50,520 (in 2021). Either way, once you hit your full retirement age, the earnings test will away and your benefits will be automatically adjusted.
It’s important to note that a reduction in benefits is different than taxation of benefits. The earnings test is a pure reduction in benefits. Any benefits withheld because of the earnings test are not set aside for taxes but are simply not paid out.
Taking Benefits Early in Fear of Insolvency Issues
Despite the drawbacks, some may still decide to start benefits early due to concerns over future insolvency of the program. However, these fears may be ill-founded.
According to the Social Security Administration, the OASDI trust fund currently holds around $2.9 Trillion. It was expected that in 2020, the costs of Social Security would exceed the program’s income. Therefore, by 2035, barring any major changes, it is expected that the OASDI trust fund will be exhausted.
While this is something that should be addressed, it’s still a far cry from Social Security going “belly up.” Social Security is a pay-as-you-go system, and even if the OASDI trust fund is depleted, income for the Social Security program will not stop.
If no changes are made to Social Security, the income made by Social Security after 2035 is estimated to cover 80% of promised benefits until approximately the 2090s. This also assumes that absolutely no changes will be made to the Social Security system between now and 2035. On the bright side, there are actually many options to fix the system.
What’s the takeaway? It may not be wise to take benefits early because of concerns surrounding Social Security insolvency issues.
3. Not Coordinating Benefits for Married Couples
Deciding what filing strategy is best for a married couple can be more complex. First off, you need to understand how benefits are treated for working and non-working spouses.
In short, a low-earning or non-working spouse is entitled to 50% of the higher-earning spouse’s PIA (as long as the working spouse has filed for benefits). If the low-earning spouse collects a benefit based on the working spouse’s earnings record, it’s known as a spousal benefit.
In the case where both spouses had similar income, it can be common for both to retire at a similar time and start Social Security benefits at a similar time as well. However, there can be major benefits to allowing at least one benefit to delay until 70. Doing so can provide added protection to one or both spouses living beyond a normal life expectancy.
Also, once the first spouse passes away, the surviving spouse is entitled to receive the higher of the two benefits (this is called a survivor benefit). If a married couple lets the higher benefit delay until 70, the surviving spouse will receive the higher benefit amount in the form of a survivor benefit. With proper planning, this survivor benefit could be much higher than the previous benefit.
Filing a Restricted Application
For couples with at least one spouse born before January 2, 1954, there may be an opportunity to implement a highly beneficial strategy known as a filing a “restricted application.” A restricted application allows an individual who is eligible for both a spousal benefit and working benefit to choose which benefit they’d like to start receiving, instead of being forced to receive the highest benefit right away (which is the current rule).
In other words, one could start receiving a spousal benefit while their working benefit continues to delay and increase. This allows one spouse to switch benefits at a later date. This is something no longer allowed for anyone born after January 2, 1954.
4. Not Maximizing Survivor Benefits
Unlike other types of benefits, survivors can begin receiving a survivor benefit as early as age 60, but it would be at a reduced rate. As mentioned above, a survivor benefit is equal to 100% of the deceased spouse’s benefit, including delayed credits. Therefore, maximizing survivor benefits starts with delaying the higher earning spouse’s benefit as long as possible. But, the opportunities to increase survivor benefits don’t stop there.
Survivors also have the unique opportunity to switch from a working benefit to a survivor benefit, and vice versa.
For example, in the case where your own working benefit is less than your survivor benefit, you can begin receiving your own working benefit at age 62 and switch to your survivor benefit at FRA, allowing your survivor benefit to earn delayed credits until that time.
On the other hand, if your working benefit is higher than your survivor benefit, you can begin receiving a survivor benefit at age 60 and allow your working benefit to earn delayed credits to age 70, and then switch to your own increased benefit.
It’s important to note that remarriage before age 60 negates these survivor benefits, unless that marriage ends.
5. Not Maximizing Divorced Benefits
The same rules that apply for spousal benefits also apply to divorced individuals, provided that the applicant is 62, was married for at least 10 years to the ex-spouse, and is currently unmarried.
Unlike in the case of a married couple, your ex-spouse does not need to have filed for benefits for you to receive divorced spousal benefits (as long as your divorce occurred more than two years ago).
Also, your filing decision does not affect the benefits of your ex-spouse, nor will your ex-spouse’s filing decision affect your benefits. If your ex-spouse remarries, his/her current spouse’s benefits will also not be impacted by your filing decision.
If your ex-spouse passes away, normal survivor benefits could also apply, meaning you could be eligible to begin receiving your ex-spouse’s full benefit.
Of course, there are even more considerations if you remarry. If your second marriage also lasts at least ten years, but then ends in death or divorce, you could be eligible for spousal and survivor benefits off both marriages.
If you have ever been divorced, widowed, or both, you may have options to maximize your Social Security benefits that you haven’t previously considered. Be sure to speak with an advisor who is well-versed in Social Security benefits to help you potentially uncover unused benefits.
6. Relying on the Social Security Administration for Advice
Unfortunately, due to the complexity of the Social Security system, even the Social Security Administration itself has struggled to provide consistent information on a case-by-case basis. In fact, Laurence Kotlikoff, a professor of economics at Boston University, was quoted in a CNBC.com article saying, “Half of the answers Social Security is giving people are wrong or misleading.”
Furthermore, an article from MoneyTips.com states that SSA employees are not allowed to give you advice on when or how to claim your benefits, but they are supposed to give you the advantages and disadvantages of filing strategies.
The article goes on to state that an audit performed by the Office of the Inspector General highlighted at least one area where the SSA has not provided the full picture to retirees, causing significant underpayment of benefits.
Social Security is a crucial part of retirement and your decision could be irrevocable. The OIG report implies that you can’t always trust the SSA to give you the right information. It’s best to do your own research so you know the right questions to ask the Social Security Administration.
7. Thinking all Social Security Decisions are Irrevocable
Some Social Security decisions are irrevocable, but not all. In fact, if you change your mind about starting your benefits, you can cancel your application up to 12 months after you became entitled to retirement benefits. This process is called a withdrawal.
However, it may not be as easy as just stopping your benefits. If anyone is receiving benefits based on your application, they must consent in writing to the withdrawal. You also must repay all the benefits you have received, including your benefit, withholdings for Medicare premiums, tax withholding, etc.
While a withdrawal is not an option if you have been receiving benefits for longer than 12 months, there is another strategy called “file and suspend” that could help improve your benefits. File and suspend essentially does what it sounds like for those between FRA and age 70. You can suspend your benefit for the purpose of accruing delayed credits until a later age (max age 70).
Why would someone choose to file and suspend? Some may decide to retire, but then go back to work unexpectedly, not needing the income from Social Security.
For example, Bob retires at age 65 and begins receiving benefits. However, Bob accepts an opportunity for a consulting job when he is 65 years old. After accepting his new position, his consulting income is all he needs to cover his living expenses. In this case, Bob could suspend his benefit so that he earns delayed retirement credits, resulting in a higher benefit in the future.
Medicare and Social Security
In many cases, and especially for those over age 65, Medicare premiums are withheld from Social Security benefit checks. If you decide to withdraw or suspend your Social Security benefit, you’ll need to be sure that your Medicare premiums are still being paid on time, so your coverage is not interrupted.
If you are withdrawing your Social Security application, you may also have the option to withdraw your Medicare coverage. However, this is a serious decision and should be taken very seriously. Withdrawing your Medicare coverage means that you must repay all Medicare Part A benefits paid on your behalf and if you file for Social Security and Medicare later, your Part B premiums may be higher due to your late enrollment.
If you are thinking about terminating your Medicare coverage, it is recommended that you have a personal interview with the Social Security Administration to get all the facts. You should also consider talking with a Medicare insurance specialist to ensure you have all the facts.
Social Security is not always as straightforward as some think and I’m consistently surprised by the lack of planning that goes into this major decision. The difference in cumulative lifetime benefits between some strategies could amount to hundreds of thousands of dollars.
Picking the best strategy is not always easy and usually depends largely on how long you live. However, with proper planning and knowledge of your options, you can make a more informed Social Security decision.
If you haven’t received a Social Security analysis for your specific situation, talk with a retirement specialist or CERTIFIED FINANCIAL PLANNER™ professional to learn about your options.