Medicare Planning: What You Need to Know to Manage Costs and Avoid Late Filing Penalties presented by Pat Burris, CFP®. The webinar will be held on February 22nd from 3:00 PM – 4:00 PM Central Time. There is no cost to attend, but you must register in advance.
Click here for more details.
Since Social Security was established in 1935, there have been many changes to the program and new legislation continues to be passed which affects beneficiaries in various ways. Updates to prior legislation and the introduction of new rules can make your options regarding Social Security more complicated. Understanding the alternatives and making appropriate decisions regarding when and how to take your benefits can help you maximize your income and accomplish your retirement goals.
For the average recipient, Social Security replaces 40% of their preretirement income, making it one of the most important sources of income for many retirees. So, be sure to avoid these common mistakes that can reduce your Social Security benefits.
9 Common Mistakes That Can Reduce Social Security Benefits
Some estimates show that making just one of these mistakes can cost you more than $100,000 over the course of your retirement. So, take care to understand and avoid these common issues.
Mistake #1 – Not Coordinating Benefits with your Spouse
Since traditional retirement savings accounts are limited to individual ownership, many people forget that their income in retirement is a joint effort with their spouse. Social Security is an important part of the financial plan for most couples nearing retirement and decisions about when to begin benefits should be based on the needs of both spouses.
Deciding when to retire and when to begin taking Social Security benefits are questions you should answer in coordination with your spouse to maximize your retirement income as a couple. To ensure you are making smart decisions, both spouses should meet with an experienced financial advisor and weigh their options before beginning Social Security. See also, mistake #6 below.
Mistake #2 Underestimating Life Expectancy
When choosing when to begin taking Social Security payments and how much to withdraw each year from savings, life expectancy is a key factor. Some people look to the age their parents or grandparents achieved when setting expectations for their own life expectancy. However, with advances in medical technology, and increased standard of living, people today are living longer than previous generations. About 1/3 of the people who are 65 today will live to at least age 90. Another 1 in 7 will live to at least age 95.
Underestimating life expectancy can lead to overspending in the early years of retirement and subsequent income shortfalls later in life. Building a retirement plan using a life expectancy that is too short can also lead some to take retirement benefits too early, reducing the monthly benefit amount and leading to lost income over a long life. When deciding on a strategy to replace income during retirement, plan for a long life to reduce the risk of outliving your savings.
Mistake #3 Thinking Social Security Benefits are Tax-exempt
It is a common misconception that all Social Security benefits are exempt from taxation. In fact, about 40% of Social Security recipients owe taxes on their benefits.
Social Security Benefits are taxed at the federal level when combined income is over certain thresholds. Individuals with income over $25,000 and couples with income over $32,000 could owe taxes on 50% of their Social Security benefits. If income is over $34,000 for individuals, or $44,000 for couples, 85% of Social Security benefits could be taxable at the federal level.
Another factor to consider when planning for your retirement is state income taxes. Some states charge tax on Social Security benefits while others exclude Social Security payments from taxable income.
Paying taxes on Social Security benefits reduces your monthly net income and could cause you to spend more of your savings to make up the difference. On the other hand, accurately estimating your tax burden in retirement can help you evaluate your required savings amount during your working years. After retirement, knowing your income after taxes can help you plan your expenses to fit within your budget.
Mistake #4 Planning for the Wrong Retirement Age
Many workers plan to retire at age 65. While this may be an attainable goal, age 65 is often not the optimal retirement age to maximize retirement income.
Due to increasing life expectancy, the full retirement age for Social Security has been increased several times and is currently between 66 and 67 for most workers. Full retirement age is based on the year in which you were born and is the age at which a worker can claim their full Social Security benefit. For those born between 1943 and 1954, the full retirement age is 66. The full retirement age for those born between 1955 and 1959 is between 66 and 67, and for those born after 1960, the full retirement is 67.
Taking benefits before your full retirement age can lead to benefits decreasing by up to 30%. For those born after 1960, benefits at age 65 are 86.7% of the full benefit amount. The reduction in benefit payments for starting Social Security early penalizes you for as long as you are receiving benefits.
Mistake #5 Claiming Benefits too Early
There are many reasons why an individual might take Social Security benefits early. Underestimating life expectancy is one common reason. However, taking benefits before your full retirement age results in a decrease in the benefit amount. For those born in 1960 or later, taking retirement benefits at age 62 reduces monthly benefit amount by 30%.
Over half of Social Security beneficiaries begin taking payments at the earliest possible age – 62. In 2006, only 5.5% of beneficiaries waited until age 66 or later to claim their benefits. While taking benefits early can be beneficial in certain circumstances, it rarely leads to a higher income amount in the long run. The majority of those who take benefits prior to their full retirement age lose money over the course of their retirement.
It is important to note that if you begin receiving benefits early, those benefits will not increase when you reach your full retirement age. The decreased benefit amount will only be adjusted for cost of living increases throughout your life.
Conversely, delaying benefits past your full retirement age increases your monthly benefit amount for as long as you receive benefits. The latest that you can delay benefits is age 70. For each year past your full retirement age that you delay benefits, your benefit amount increases by 8%. For those with a full retirement age of 66, delaying benefits until age 70 increases the monthly benefit amount to 132% of the full retirement benefit amount.
Choosing when to take Social Security benefits is one of the most important decisions that you will make when planning for your retirement. Receiving benefits too early can lead to lost income down the road but delaying benefits after your retirement can lead to overspending from savings accounts to bridge the gap. An experienced financial advisor can help you make an informed decision to maximize your Social Security income without unnecessarily drawing down your savings.
Mistake #6 Forgetting to Account for Spousal Benefits
Spouses are entitled to a Social Security benefit equal to one half of their spouse’s benefit. This is especially important in one-earner households or in households where one spouse has not worked enough to qualify for their own Social Security benefit.
In two earner households, if one spouse has earned significantly more during his or her lifetime, the spouse that earned less can claim their own retirement benefit and spousal benefits. They will receive a combination of their own retirement benefit and a spousal benefit up to the amount of the spousal benefit.
Spouses can begin taking payments at age 62, but like regular benefits, the payout will be reduced if they begin taking payments before their full retirement age. In contrast with regular benefits, delaying payment past full retirement age do not increase the amount of spousal benefits.
These special rules can make it more difficult to determine the optimal time to take benefits for couples that will rely on spousal benefits during retirement. There are several strategies for maximizing total income when spousal benefits are part of your retirement plan, and it is advisable to work with a knowledgeable financial advisor to weigh the pros and cons of each.
Mistake #7 Overlooking Survivor Benefits
Widows, widowers, and dependent children may be able to claim benefits after the death of a spouse or parent. Ex-spouses may also be entitled to survivor benefits if the marriage lasted more than 10 years and they have not remarried. Survivor benefits can be automatic in some cases where the surviving spouse is not currently receiving their own Social Security benefits. If the survivor is already claiming their own Social Security benefit, they will need to apply for survivor benefits through the Social Security Administration.
Unlike spousal benefits, survivor benefits can begin at age 60 for retirement benefits or earlier in the case of disability or to care for minor children. The amount of survivor benefit is based on when the original recipient began taking their Social Security benefits and when the survivor begins taking benefits.
Since survivor benefits can be taken earlier than retirement or spousal benefits, understanding the rules regarding these types of benefits are especially important for those who are nearing retirement but have not yet begun receiving benefits. If you are entitled to survivor benefits for a spouse, ex-spouse, or other family member, it can affect when you choose to claim your own retirement benefits.
Mistake #8 Failing to Plan for your Death
For couples, it is important to have a plan in place to ensure the wellbeing of your spouse after your death. Many couples get accustomed to receiving two Social Security payments during retirement and it can be a challenge for a surviving spouse to adjust to a lower income. After one spouse dies, the surviving spouse receives the higher of their two benefit amounts and the lower amount stops. Even though the surviving spouse receives the higher amount, this can still leave an income gap that must be bridged by either increasing withdrawals from retirement accounts or decreasing living expenses.
To ensure that your spouse doesn’t run out of money after your death, there are a few steps that you can take. The higher earner can delay taking their Social Security payments until age 70 to make sure that the benefit is the highest amount possible both during life and after death. You could also increase your savings amount prior to retirement to ensure that there are sufficient savings to pull from to make up for the loss of income.
Mistake #9 Not considering the Earnings Test
If you have earned income while you are receiving Social Security, you may be subject to the earnings test. This test only applies to those who are receiving benefits prior to their full retirement age, including those receiving survivor or spousal benefits prior to their full retirement age. Click here to learn more about the earnings test.
Because of the Earning’s Test, those that are working and receiving Social Security payments prior to their full retirement age may see their benefits reduced based on their income. In 2021, the annual threshold is $18,960. For every $2 earned over that threshold, $1 will be withheld from your benefit amount. The year that you meet full retirement age, the threshold increases significantly. For those attaining full retirement age in 2021, the annual exempt amount is $50,520. For every $3 you earn over that amount, $1 is withheld. Only the income earned in the months prior to the month you reach full retirement age is counted toward the threshold.
However, there is some good news. When income is withheld, it is not lost. Once you reach your full retirement age, your monthly benefit is permanently increased to account for the months during which your benefit was decreased. Even though your monthly benefit is increased to account for the withholding, the withheld amount is paid back to you over the course of several years, based on your life expectancy.
Taking benefits prior to your full retirement age is rarely beneficial in the long run but becomes even more undesirable if you are still working and earning more than the excluded amount under the earnings test. To learn more about the intricacies of Social Security, view our on-demand Social Security webinar.
Plan for Retirement with Financial Fingerprint™
If you would like to discuss how to maximize your Social Security income, or need help planning for your retirement, Meld Financial can help. Our team of financial, legal, and tax professionals have spent over 30 years helping our clients achieve their retirement goals.
Our experience managing our clients’ wealth has allowed us to develop a unique financial planning process called Financial Fingerprint™. This is a comprehensive financial plan that is quick to assemble, easy to understand and simple to modify as your circumstances change. To get started with your Financial Fingerprint™, contact us today.