Investment Strategy

08/06/03 - Social Security: Does It Pay To Take It Early?

By: Richard Feldman, CFP, AIF

When should you take your Social Security? The right answer is there is no right answer. The decision comes down to a myriad of factors like your family's health history, taxes, and whether working longer is an even an option.

The decision process should not be taken lightly. Social Security is a key component of a retirement plan and is often one of the biggest investments a retired couple has. The value of lifetime security benefits to an average-wage-two earner couple that turned 65 in 2000 was $300,000. (The figure is the present value, in 2002 dollars, of lifetime benefits). 1

Social Security System

Our future benefit is derived from a formula that takes into account a workers average indexed monthly earnings and the number of years of actual work. According to the Social Security website an average worker who retired in 2002 at age 62 received a starting monthly benefit of $936. A worker whose salary was always around the Social Security wage base maximum ($84,900 in 2002 and $87,000 in 2003) received a monthly benefit of $1,382.

Beginning with persons born in 1938, the full retirement age (FRA) gradually increases from age 65, eventually reaching age 67 for persons born in 1960 and later. If you decide to wait till full retirement age then you receive 100% of your projected benefit. However, if you are fully insured you can claim permanently reduced benefits as early as the first full month that you are age 62. Accordingly, the benefit is reduced by 5/9 of 1% for each of the first 36 months he or she is under the normal retirement age when the benefits begin, and by 5/12 of 1% for each such month in excess of 36 months. As an example, you would receive 76.6% of your full retirement age benefit should you decide to receive your benefits at age 62.

Here is an example:

A person who turns 62 this year (Year of Birth is 1941) would be eligible for full retirement benefits at 65 years and 8 months. Say their monthly benefit they would receive at (FRA) would be $1,000. The monthly benefit at age 62 would be $766 (76.6% of $1,000).

Most financial planners and CPA's crunch the numbers and tell you that you have a 12 year crossover before the reduction of benefits equals the initial advantage of receiving retirement benefits early. In taking retirement benefits early in the above example you would receive $33,704 ($766 x 44 months) of benefits before normal retirement age. The crossover point is calculated by taking that $33,704 and dividing it by $234 permanent benefit reduction, which equals 144 months or 12 years. The crossover point in this example would be at age 77 and 8 months.

Mortality Rates

I occasionally hear that it pays to take Social Security benefits early because you may never live to see the crossover point from delaying retirement benefits till full retirement age. The facts don't bear that out. At age 65 a man has a 60.2% chance of living an additional 15 years to age 80. At age 65, a woman, has a 73.7% chance of living an additional 15 years to age 80. The odds clearly favor longer lives.

Earnings Limits

After a worker reaches full retirement age, full benefits will be received without loss or reduction due to earnings. Before the year 2000 only those who had reached age 70 were able to have unlimited earned income and avoid benefits reductions. The law was changed in 2000 to eliminate the benefits reduction for those who reached normal retirement age. Workers who have full retirement age in 2003, will have a reduction in benefits for the months before the worker turns 65 of $1 for every $3 of earnings over $30,720. Workers below the age of 65 lose $1 of benefits for every $2 of earnings above $11,520 in 2003. Earnings generally are considered income from gainful employment and not pensions or qualified retirement distributions.

Taxes

Income taxes are another big part of the puzzle. Benefits are income tax free for the majority of beneficiaries and partially tax-free for all beneficiaries. However, those with high total incomes must include up to 85% of their benefits as income for federal income tax purposes. Special thresholds determine the amount on which you may be taxed.

Single persons: $25,000 and $34,000.
Married Couples filing a joint return: $32,000 and $44,000.

The formula to figure out the taxation of benefits starts with preliminary adjusted gross income (earnings, pensions, dividends, and taxable interest from investment sources), plus interest on tax-exempt bonds plus 50% of Social Security is compared with these thresholds. Fifty percent of any excess over the first threshold, plus 35% of any excess over the second threshold is included in Adjusted Gross Income. This amount cannot exceed the smaller of (a) 85% of the benefits or (b) 50% of the benefits plus 85% of any excess over the second threshold.

Electing to receive Social Security benefits before full retirement age while you are still employed would subject you to the earnings penalty (explained above) in addition to having a higher percentage of your benefits subject to taxation. An individual analysis of your current and future circumstances should be performed in order to maximize your retirement benefits and minimize taxes.

Delayed Retirement Credits

Once you have reached full retirement age you may begin collecting 100% of your Social Security benefits. However, a small percentage of people, who are still gainfully employed may choose to have their benefits suspended up to as late as age 70 in order to earn delayed retirement credits. There are at least three reasons why you might choose to delay benefits.

Your income from earnings while working may be adequate, and the delayed retirement credits will increase your benefit when income from Social Security is needed more.
More of your benefits may be subject to income taxes if they are received while you still have income from working.
The delayed retirement credit will increase the benefit payable to your widow or widower.

The table below shows the scheduled delayed retirement credit rates:

Year of Birth	DRC Per Year
1931-32	5.0%
1933-34	5.5%
1935-36	6.0%
1937-38	6.5%
1939-40	7.0%
1941-42	7.5%
1943 & Later	8.0%

Planning

Now you can see why there is confusion with regard to Social Security. There are no hard and steadfast rules when dealing with Social Security. Each individual or couple should do an analysis of their current retirement situation and see what makes sense. Each person's scenario will probably lead to a different answer but the analysis has to be thorough because Social Security can be a very big piece of the retirement puzzle. With the advance of modern medicine and increase in longevity for the average American delaying Social Security could be an optimal way to maximize your retirement benefits.

Further Reference

Every person receives projections of their benefits from the Social Security office yearly. The Social Security administration also has an excellent web sit at http://www.ssa.gov/ that you can do research on.

1 MSN Money, The Basics-For a richer retirement, just wait, Burns, Scott