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FRAs, PIAs . . . and UFOs? What Married Couples Really Should Know About Social Security Back to Articles of Interest Author: David Juliano, CLU® When the first social security benefits were paid out in 1940, the ratio of workers to retirees was 15 to 1. Today, there are 152 million workers and 46 million retirees—a ratio of about 3 to 1. And an influx of retiring baby boomers and workers who are choosing to take early benefits (and living longer) are conspiring to put even more pressure on the Social Security system.According to the 2009 Social Security Trustees Report, an annual actuarial status of the system, the social security trust funds were expected to have an annual surplus of $137 billion in 2009. In fact, surpluses are projected each year until 2023. Beginning in 2016, however, inflows are projected to be less than benefit payment outflows, requiring the need to tap into those surpluses. The report projects that the reserves will be depleted by 2037, at which time social security will depend solely on a “pay as you go” system, with benefits to retirees coming solely from contributions from workers. It is this projection of a depleted surplus that has contributed to Americans’ concerns over the future of social security. Indeed, a recent survey showed that a large number of young people believe they have a greater chance of seeing a UFO than receiving their social security benefits. You probably have boomer clients who share these concerns and wonder whether their benefits will be reduced someday. Maybe they’re thinking that taking benefits early isn’t such a bad idea—just in case the worst happens. But there are some potential drawbacks to such an approach, especially for married couples who are trying to factor in both worker and spousal benefits, and advisors need to be prepared to discuss these nuances of social security as they relate to retirement income planning. BENEFIT CALCULATIONS Social security retirement benefits are based on a worker’s full retirement age (FRA), which is age 66 for individuals born in the years 1943–1954 and gradually increases to age 67 for those born in 1960 or later. An individual’s benefit at FRA is referred to as his or her primary insurance amount (PIA). The formula for calculating the PIA looks at an individual’s highest 35 years of earnings, adjusted for inflation. If a worker doesn’t have 35 years’ worth of earnings, those years without earnings have a value of zero. Workers who elect to receive benefits prior to their FRA will experience a permanent reduction in their benefits. The reduced benefit formula works out to a 6.67-percent reduction per year for benefits taken up to three years early. For benefits taken more than three years early, each additional year represents a 5-percent reduction. So a retiree with an FRA of 66 who elects to take benefits at age 62 would see a 25-percent reduction in benefits. It’s a fairly straightforward approach, but it gets more complicated when spouses are involved. EARLY CLAIMS AND SPOUSAL RATES When a married individual applies for retirement benefits, the Social Security Administration (SSA) checks eligibility both for the worker’s own retirement benefit and for a spousal benefit. If the individual is eligible for both benefits, the SSA will pay an amount equaling the higher benefit. If a worker’s own benefit is higher, the SSA will pay only that individual benefit. If the spousal benefit is higher, the SSA will still pay the individual worker’s benefit, but it will top off the payment with an additional amount so the full payment equals the higher spousal benefit. It’s important that clients understand the composition of this payment: they are still receiving their own benefit; they are not receiving delayed credits on that benefit. The above scenario occurs when individuals apply for benefits prior to their FRA and their spouses have also applied for their benefit. If a wife applies for benefits at age 62, but her husband has not yet applied for his benefits, she would only be able to receive her own benefit at that time (assuming she has an earnings record). If she elects to receive her own benefit at age 62, she is not entitled to a full spousal benefit upon reaching her FRA. Electing to receive her own benefit early permanently reduces her benefit, as well as the spousal benefit rate. The full spousal benefit payment is 50 percent of the worker’s PIA. This is paid when spouses claim the spousal benefit at their own FRA. If a spouse with an FRA of 66 claims benefits at age 62, he or she is only eligible to receive 35 percent of the spouse’s PIA. The spousal benefit rate is not impacted by the age at which the other spouse claims benefits, however. If a husband applies for benefits at age 62 based on his own working record, his benefits will be permanently reduced. If his spouse waits until her FRA of 66, she will receive 50 percent of the husband’s PIA, which he would have received if he claimed at his FRA. For example, let’s assume that the husband was entitled to a benefit of $1,000 per month at his FRA of 66, but he applies for benefits at age 62 and receives $750 per month. If his spouse applies for benefits at her FRA of 66, she is entitled to a spousal benefit of $500 per month—half of $1,000, not half of his reduced benefit. CLAIMING AT FRA OR BEYOND The SSA offers married couples a critical planning opportunity when either spouse waits to receive benefits at his or her FRA. When married individuals apply for benefits at their FRA, they are no longer automatically paid the higher of their own benefit or the spousal benefit. They can choose which benefit—worker or spousal—they want to receive. Let’s assume we have a married couple and the husband is four years older than his wife. If she decides to claim benefits early at age 62, he would be 66 at that time. Since the husband has reached his FRA, he could claim benefits now and elect to receive only a spousal benefit. He would also qualify for the maximum spousal benefit rate of 50 percent. The husband could then delay receiving his own benefit and accumulate delayed retirement credits. If he waits until age 70, he will maximize the benefit available based on his own record. The system provides a strong incentive to delay benefits. After FRA, for each year workers delay receiving their own benefit, the payment increases by about 8 percent. Someone who would receive $1,000 per month at age 66 would receive $1,320 if he or she began benefits at age 70. This strategy also has an additional planning benefit. If the husband in our above example is expected to predecease his wife, she would be entitled to 100 percent of his benefit upon his death. By delaying his benefits in order to receive a higher payout, he has left his spouse with a higher survivor benefit to step up to upon his death—nullifying the effect of her reduced benefit since she started at 62. ILLUSTRATING THE SCENARIOS These scenarios may make sense to clients conceptually, but it’s often helpful to illustrate different social security claiming strategies to tie in the benefits with other sources of retirement income. Some software programs automatically estimate a client’s social security benefit based on the stated retirement age, but both programs also allow you to override the estimate and enter other monthly benefit amounts based on when clients start benefits and whether they are receiving their own benefit or a spousal benefit. This will help clients see how delaying benefits and/or taking advantage of spousal benefit options can positively impact their retirement income planning. Proficiency with the nuances of the Social Security system and the various payout options will help to enhance the retirement income planning services you offer to clients. With fewer defined benefit plans and pensions available to retirees, and an increased emphasis on self-funding the majority of the retirement income need, the social security benefit may be the only inflation-adjusted, lifetime-guaranteed payment some clients receive. No one really knows what the future holds, but if your younger clients start showing you pictures of UFOs, you can remind them that in the 70 years since the Social Security system has been paying benefits, every payment has been made in full and on time. David Juliano is an advanced planning consultant. He is available at x9481 or at djuliano@commonwealth.com. |
 
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