Managing retirement savings during turbulent markets
Morgan Stanley private wealth adviser Mary Deatherage joins Barron’s Roundtable to discuss what retirement savings options will help generate income in a low-yield environment.
As of June, the average retired worker was bringing home $1,514 a month from Social Security. This works out to almost $18,200 a year. All things considered, this isn't very much — but for 62% of retired workers receiving a Social Security benefit, their monthly payout will account for at least half of their income.
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The critical role Social Security plays during retirement for so many elderly Americans demonstrates just how important your claiming decision can be.
Claiming age plays a big role in determining your Social Security payout
Although there are more than a half-dozen factors that can affect how much you'll receive and get to keep of your Social Security retirement benefit, there can be an up to 76% difference in monthly payout, all things being equal, between claiming your benefit as early as possible (age 62), or waiting until age 70. That's because benefits increase by as much as 8% annually for each year a worker holds off on taking their payout until age 70.
Statistically speaking, a majority of seniors would be better served by waiting until age 70 to begin taking their Social Security retirement benefit. But this doesn't hold true for everyone.
In certain instances, an early claim can make a lot of sense. For example, a person with one or more chronic health conditions may not live to see the average life expectancy in the U.S. of nearly 79 years. Thus, an early claim — even at a rate reduced by as much as 30% per month — can still lead to a retired worker maximizing what they receive over their lifetime from Social Security.
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But there are also many scenarios in which claiming Social Security benefits early would be a terrible move. Here are five such cases.
1. You’re in debt and want the extra income stream
With a growing number of seniors dealing with debt, it can be tempting to try to double dip on income to pay down or eliminate debt. You might think that claiming benefits early and combining this added income with your wages or salary is a smart move, but you'll almost certainly be in for an unpleasant surprise.
You see, Social Security has a rule built in for early filers (i.e., those who claim benefits before reaching their full retirement age) known as the retirement earnings test. Without getting too deep into the weeds, the retirement earnings test allows the Social Security Administration to withhold some or all of your Social Security benefits if you earn too much money. For beneficiaries who won't reach their full retirement age in 2020, $1 in benefits will be withheld for every $2 in earned income above $18,240. For Social Security beneficiaries who will reach full retirement age in 2020, $1 in benefits is withheld for every $3 in earnings beyond $48,600.
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The point is, if you're looking to claim benefits early to pay down debt, there's a good chance some or all of your benefits could be withheld if you're still working, thereby defeating the purpose.
2. You’re wealthy
Taking an early claim is also usually a bad move if you're rich and won't rely in any way on Social Security.
Though an argument could be made that an early claim will allow the rich to use their Social Security income on trips and hobbies, there are two good reasons for the well-to-do to wait to take their payout.
First of all, waiting might mean a lower tax bill. Social Security benefits are indeed taxable at the federal level if recipients cross certain earning thresholds. If the well-to-do hold off on taking their payout, they won't need to worry about added federal tax in those years.
Second, the rich substantially outlive low-income workers. Because the wealthy have little or no financial constraints when it comes to accessing preventative care or prescription medicine, they tend to outpace the average life expectancy in the United States. A later claim (i.e., age 70) would allow long-lived beneficiaries to collect the most from Social Security.
3. You’re in excellent health
You might have seen this coming due to the example I'd provided earlier, but if you're in excellent health, an early claim often doesn't make much sense.
To some degree, claiming Social Security benefits based on health comes with an asterisk. None of us (thankfully) knows our own expiration date. But without this knowledge, choosing the optimal claiming age is a bit of a crapshoot. We use the information we have at our disposal, such as our own health history and that of our immediate family, and we make an educated decision on when to begin taking benefits.
That said, longevity has been increasing for quite some time. The average life expectancy of an American born today is over 16 years longer than when the first retired worker benefit was paid out in January 1940. With the average 65-year-old beneficiary living another two decades, it usually pays for folks in good to excellent health to hold off on taking their benefit.
4. You’re a higher-earning spouse
Far more often than not, it would also be a mistake for a higher-income spouse to claim their benefits early. Though there's an obvious desire to generate household income, waiting makes sense for two key reasons.
Waiting will have a greater impact on future payouts for a high-earning spouse. Maybe waiting to claim benefits at age 70 isn't in the cards, but accepting an up to 30% reduction for taking a payout at age 62 could substantially reduce the monthly and lifetime earning potential for a married couple.
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The other reason is that claiming Social Security prior to reaching full retirement age could reduce the survivor benefit for a lower-earning spouse, should the higher earner pass away first. A survivor has the ability to max out their survivor benefit, but only if the deceased spouse waited until their full retirement age to begin taking their payout.
In sum, waiting to claim Social Security can help to build a financial foundation for your significant other.
5. You don’t believe Social Security will last much longer
Finally, claiming benefits early because you believe the Social Security program won't last much longer is an absolutely awful idea.
There's no denying that Social Security has its issues. The latest Social Security Board of Trustees report estimates the program is facing a $16.8 trillion cash shortfall between 2035 and 2094, which could lead to sweeping benefit cuts of up to 24% for retired workers if not dealt with.
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However, Social Security is also basically incapable of going bankrupt. Two of the program's three sources of revenue — the 12.4% payroll tax on earned income and the taxation of benefits — are recurring. As long as the American public keeps working, money will continue to flow into Social Security for disbursement to eligible beneficiaries. Translation: Social Security will be there for you in some form, no matter when you retire.
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