Social Security benefits represent a valuable source of guaranteed income individuals can count as part of a retirement strategy. However, creating a strategy for claiming these benefits is not as straightforward as it may seem. In order to create an optimal strategy, it is important to first understand the different types of benefits and when they might become available.
Types of Retirement Benefits
The Worker Benefit
If you have worked and contributed to the Social Security system for 40 quarters, you are likely eligible for a worker benefit. This benefit, at your Full Retirement Age, is known as the Primary Insurance Amount (PIA). The earliest you can file for your worker benefit is the first month in which you are age 62 for the full month. As a result, most individuals are first eligible for their worker benefit at age 62 and one month. Actuarial reductions apply if you take your benefit prior to your Full Retirement Age. The Full Retirement Age is 66 for those born between 1943 and 1954. If you wait beyond your Full Retirement Age to claim your benefits, a Delayed Retirement Credit of 8% per year will apply. While you are waiting to claim your benefits at any age from 62 to 70, COLAs will also apply and compound over time. For example, if you wait from age 68 to age 69 and the government has declared a 3% COLA, your benefit will grow 11% (8% Delayed Retirement Credit plus 3% COLA) for that year.
The Spousal Benefit
Assuming that the other spouse has filed for benefits, spousal benefits can begin the first full month that an individual is age 62. Spousal benefits, however, do not earn Delayed Retirement Credits if a benefit is delayed past Full Retirement Age.
This benefit is often thought of as being the greater of what a spouse earns on his/her own work record, or one-half of the other spouse’s benefit. Unfortunately, it gets more complicated than that. To understand how the spousal benefit works, let’s assume that we have a married couple in which Ken was the higher earner, Mary was the lower earner, and both turn age 62 (and become eligible for benefits) on the same day in 2017. Let us also assume that Ken and Mary’s Full Retirement Age is 66.
If Ken has filed for his worker benefit, a spousal benefit may be payable to Mary. The simplest way to consider whether Mary is eligible for a spousal benefit when she is younger than 66 is to determine what her worker benefit is at age 66. This amount is her PIA. Ken also has a PIA calculated at age 66. If Mary’s PIA at 66 is less than one-half of Ken’s PIA at 66, then Mary is eligible for a spousal benefit. The spousal benefit amount will be the difference between Mary’s PIA and one-half of Ken’s PIA. Therefore, although many might think that Mary is receiving a large spousal benefit based on Ken’s work record, she actually is receiving two benefits—her own worker benefit plus the spousal benefit. It bears repeating that Ken must have filed for his worker benefit for Mary to become “entitled” to a spousal benefit. Both a worker benefit and a spousal benefit (if the other spouse has filed) can be taken earlier than age 66 and are subject to actuarial reductions. Worker and spousal benefit reduction amounts are at different rates (with reductions slightly higher for spousal benefits).
To see how the numbers work, let’s assume that Ken is eligible for a worker benefit of $2,000 per month at age 66 (his PIA). Let’s further assume that Mary is eligible for her own worker benefit of $600 per month at age 66 (her PIA). One-half of Ken’s PIA ($1,000) minus Mary’s PIA ($600) leaves Mary eligible for an additional $400 in the form of a spousal benefit. If Ken and Mary filed at age 66, Ken would receive $2,000 and Mary would receive $1,000. Mary’s $1,000 might be thought of as a spousal benefit, but it really is made up of two parts, her own worker benefit ($600) and her spousal benefit ($400).
Following are some important things to consider, as there is often confusion surrounding the payment of spousal benefits. First, Ken could start his worker benefit early, and his $2,000 would be reduced. For example, he might claim his benefit at age 62 at a reduced amount of $1,500 per month (75% of his PIA). Even if Ken started his benefits early, Mary could wait until her Full Retirement Age to start all her benefits and still receive the full $1,000. In other words, the $400 spousal benefit is not reduced, even though the worker on which they are based (Ken), started his benefits early.
Second, if Ken has filed for benefits, Mary cannot file for only one type of benefit. If she files for her worker benefit or her spousal benefit, she is “deemed” to be filing for both. This holds true because Mary was born after January 1, 1954. If she was born on or before this date, she can choose to file for only a spousal benefit at her Full Retirement Age. See Chapter Two for an explanation as to why this may be beneficial.
Third, if Ken does not file for his worker benefit early, Mary cannot file for her spousal benefit. If Ken waits until age 66 to receive his full, unreduced amount of $2,000, and Mary wants to file at an earlier point, she can only apply for her worker benefit of $600, subject to actuarial reductions. For example, Mary could apply for her worker benefit at age 62 and receive $450 (75% of her PIA). At age 66, once Ken has filed for his worker benefit, she would receive an additional $400. At that point she would be receiving $850 (plus any COLAs), not $1,000. Many are under the impression that Mary’s benefit would increase to one-half of Ken’s benefit once he applied, but this is not the case. By starting her worker benefit early, she locks in a permanent reduction on this benefit. The spousal benefit is added on later in this example. Of course, if Mary took the spousal benefit at any age prior to age 66, then it would be subject to a separate actuarial reduction. For example, if Ken filed for his worker benefit at age 65 and Mary decided to start her spousal benefit at age 65 as well, the $400 potential spousal benefit would be permanently reduced to $366 because Mary started 12 months early.
The Survivor Benefit
Delaying Social Security not only increases an individual’s own benefit, but can also increase the benefit to a surviving spouse. The survivor benefit becomes available to a surviving spouse at age 60, and is calculated as the greater of:
In essence, the value of delaying Social Security continues, as the higher benefit (which has grown even higher due to COLAs) is passed on at death to a spouse (See Figure 1). This is an important way to help provide income protection to a surviving spouse. It is also worthwhile to note that the smaller benefit drops off at this time. As a result, no matter which spouse dies first, the smaller benefit will drop off. This lessens the value of delaying Social Security for the spouse with the smaller Social Security benefit, and should be a consideration as to when this spouse should claim benefits.
The transition from traditional defined benefit (DB) pension plans to defined contribution (DC) plans like 401(k)s will make more spouses vulnerable to the risk of running out of money later in life; the qualified joint and survivor annuity, which is mandated in DB plans, is often not part of a DC plan offering. A larger Social Security income survivor benefit could help offset potential healthcare costs, nursing home costs, and everyday expenses. It also helps protect surviving spouses from inflation (since they’ll receive annual COLAs). Plus, it costs nothing more for this additional benefit. Better still, the larger Social Security survivor benefit is taxed at a lower rate than other ordinary income. It’s difficult to reproduce this security for a spouse through other financial vehicles.
- The surviving spouse’s own then-current benefit, including any COLAs; or
- The deceased spouse’s then-current benefit, including any COLAs. (In this case, the current benefit [#1] drops off whether it was a worker benefit, a spousal benefit, or some combination of the two.)