To Claim or Not to Claim: When Should Your Clients Take Social Security?

Tax Law and News Couple With Financial Advisor

Deciding when to collect Social Security benefits has become an essential financial consideration for most American families. Yet, Social Security is often misjudged by many of its beneficiaries.

Tax professionals who work with retirees know their clients are often inclined to collect benefits as early as possible, without planning to maximize the utility of their family’s overall benefit. The timing of benefits, regarding an earlier or later start date, may mean the difference between a higher or lower aggregate benefit. Further, the income stream the benefit provides, which may make up a material portion of a retiree’s cash flow in retirement, will differ. Helping your clients optimize this income stream is of heightened importance in the current confluence of low interest rates and rising life expectancies.

Social Security Key Ages. As a worker, the earliest eligibility to claim Social Security benefits is at age 62. However, by collecting payments before full retirement age (FRA), a reduction in the monthly benefit will result. Current retirees who elect to take benefits at age 62 will have their monthly payment reduced by 25 percent. Conversely, if current retirees elect to begin receiving benefits after their FRA, they will receive an 8 percent annual increase in benefits for each year the benefit is delayed. The government’s designated FRA depends on year of birth and varies from age 65 to 67. For those born in 1937 or earlier, the FRA is age 65. For those born 1938 to 1959, the FRA ranges from 65 and two months to 66 and 10 months, and for those born in 1960 and later, the FRA is age 67.

Evaluate the Options. Since every family’s situation is unique, there is no one-size-fits-all solution. If clients can be flexible in their decision, you should help them assess the financial advantage of all the options available. First, ascertain the after-tax benefit amount and how that cash flow, along with other sources of income, will finance the client’s lifestyle in retirement. While it’s commonly beneficial to wait until age 70 to receive benefits, some may need the income earlier, lacking the financial resources required to cover the cost of living during the delay years.

Employment Considerations. Clients who elect to take benefits while still working, before reaching full retirement age, will receive a benefit, reduced by $1, for every $2 earned above $15,720. Starting with the month full retirement age is reached, all benefits may be received with no limit on earned income. As a result, it becomes important to analyze the earned income that’s forfeited when ending full-time work and taking Social Security early. Further, it is imperative to remind clients that they will not be eligible for Medicare until age 65. The cost of private health insurance, in the meantime, may squander the bulk of the Social Security payments. You can advise your clients why it may not make sense to permanently reduce benefits to essentially pay for health insurance. Of course, not everyone can keep working, but it is certainly a consideration if clients are healthy and can remain in the workforce.

Spousal Considerations. It is a complicated analysis with many possibilities to consider when two benefits are at stake. For married couples, think about the health factor for two people and consider that the surviving spouse is entitled to a survivor benefit. When the first spouse dies, the surviving spouse receives the higher of their own benefit or their spouse’s benefit. Therefore, depending on the situation, it may be effective to wait to receive the worker’s maximum benefit, not for the worker, but ultimately, for the surviving spouse. Before attempting to maximize the spousal benefit, be sure to carefully analyze income sources, available assets and life expectancies.

Taking Benefits Early. The advantage of collecting benefits early is that the inflation-adjusted income stream starts earlier. However, as previously stated, the disadvantage is that the monthly benefit amount is reduced. In certain situations, the need for an earlier income stream is greater than the benefit for delaying until later in life. Early benefits can certainly be of value when clients have no other sources of income, or when income is not sufficient to cover daily lifestyle needs. In addition, if a client is not in good health, he or she may not live long enough to secure the rewards of delaying, so taking early benefits makes good sense.

Full Retirement Age. By waiting until FRA, the full benefit earned is available without any reduction, and the recipient may continue to work without the lowering of Social Security benefits. This is a middle ground approach that does not rely on a long or short life expectancy. The timing and amount of cash flow is also meant to strike a balance.

Delaying Benefits. If clients can wait, it may be a worthy strategy to wait until age 70 to receive the maximum benefit available. By delaying Social Security, while drawing upon other funds or earning income to meet living costs during the delay years, clients can lock in a far greater income stream. The higher inflation-adjusted payments make delaying benefits appealing to many retirees. One way you can measure the financial efficacy of this strategy is to calculate the break-even point. The break-even point is the age when total Social Security income from the delayed strategy equals the income from taking the benefit at an earlier date.

Providing Guidance. Social Security is a complex benefit that can have a material impact on retirement cash flow. Because every family’s situation is different, it is a highly personal decision that involves balancing many considerations, including sources of retirement income, cash flow needs, health factors, employment status, marital status and lifestyle goals. Accordingly, you can help your clients think through all the considerations to leverage the most from their Social Security benefits.

Editor’s note: For more information, check out “Year-End Tax Tips for Your Clients Who Are Retired” on the Intuit® ProConnect™ Tax Center.