March 14,?2012
For people about to retire?and many folks who already have?figuring out how to make the most of their Social Security benefits usually requires a combination of strategy, informed guesswork, careful planning, calculation, and quality time with a tax advisor or CPA. But don't be discouraged?while your situation may be unique, you probably share questions and concerns with a lot of other people. Here are answers to some of the questions we hear the most:
Are Social Security payments based on average lifetime income?
Social Security benefits generally are based on the average of your 35 highest years of earnings indexed for inflation. Years in which you had low earnings or no earnings can be counted to bring the total years of earnings up to 35. That said, keep in mind that most people need 10 years of work (40 credits) to qualify for benefits.
When does it make sense to collect Social Security early, and when does it make sense to delay?
The answer depends largely on how long you expect to live. Starting Social Security , but it also means you'll receive monthly checks for a longer time. On the other hand, starting Social Security later results in fewer checks over your lifetime, but those checks will be larger. Theoretically, it shouldn't matter when you start as long as you have an. But, in reality, about half of us will live longer than average.
A big factor in your decision is how long you expect to live. There is no way to know for sure, but if you?re in good physical shape, don't have any chronic illnesses or bad habits, and have a history of longevity in your family, then the general rule of thumb is that you should wait as long as possible to collect benefits. You will receive your until age 70, so it never makes sense to wait past that age.
If you don't expect to reach average life expectancy, then it might be better to take the money early. Just don't forget to consider your spouse. If your spouse earned less than you did during your working lives, and you expect that your spouse might live longer than you, then think about whether it makes sense for you, the higher-earning spouse, to postpone benefits as long as you can in order to maximize your spouse's .
If you start taking Social Security at age 62, will the monthly amount automatically increase once you reach full retirement age?
No. For benefit purposes, the Social Security Administration (SSA) defines the full or (NRA) as between 66 and 67 for people born in 1943 or later. If you start collecting benefits before your NRA, that will result in a in your monthly Social Security check. SSA may give you an annual cost-of-living increase, but that?s it.
If I'm retiring early, should I take Social Security first and avoid tapping my 401(k) and IRA?
In isolation, it can make financial sense to postpone receiving Social Security as long as possible?assuming you have the discretion to do so, are in good health and expect to beat . Also, it's generally best to postpone tax-deferred account withdrawals for as long as you can.?
So all else being equal, the preferred place to start tapping is taxable-account money. But if you need extra money to live on at age 62 and the only choice is between taking early Social Security or tapping tax-deferred retirement accounts, then you need to crunch the numbers to see what makes sense.
Basically, it depends on how much return you expect to earn on your tax-deferred investments, such as your IRA and 401(k). The higher the expected return, the more sense it makes to leave that money alone and for the additional cash flow you need now. The level of return that favors going one way or the other will vary depending on the facts and circumstances?your benefit and life expectancy, for example. For someone who anticipates living a long life, an expected return on tax-deferred assets below 5% or so would likely favor , while an expected average annual return on tax-deferred accounts above 5% would generally favor taking the early Social Security and postponing tax-deferred account withdrawals for as long as you can.
Can I repay the Social Security Administration for benefits I've already received and then restart benefits later at a higher amount? When does this make sense?
If you previously elected to receive early Social Security benefits at a reduced rate, you do have the option of paying back to the government what you've already received and then restarting benefits at a later date to take advantage of a higher payout. This option is limited to one year's worth of benefits.
For example, let's say you elected to receive early benefits at age 62 and you're now 63 and thinking of going back to work. You could stop receiving Social Security, pay back the one years' worth of benefits you received, go back to work, and then wait until a later age to restart your benefit checks at a higher level. (You will receive your largest benefit by delaying retirement until age 70, so it never makes sense to wait past that age.)
Paying back prior benefits is similar to buying an annuity, except that you don't have to pay any interest on the benefits you've already received and there are no fees (which is why the SSA decided to limit this option to only one year).
As to your second question?whether it makes sense to take advantage of this option?it depends on your tax situation, your age and life expectancy. Of course, you also have to come up with the repayment money. You might want to enlist the help of a certified public accountant (CPA) or another financial professional to help you crunch the numbers. For important details about repaying benefits please read the SSA publication, . If you determine that it makes sense for you to repay your benefits, you can get the process going by filling out Form 521, Request for Withdrawal of Application.
I'm already collecting Social Security. How will going back to work affect my benefits?
If you haven't yet reached your full or (NRA is between 66 and 67 for those born in 1943 or later), earning a wage could reduce your benefits.
For example:
- If you go back to work before the year you reach your NRA, $1 in benefits will be deducted for every $2 you earn above the (which is $14,640 in 2012).
- In the year you reach your NRA, $1 in benefits will be deducted for every $3 you earn above a ($38,880 in 2012), but that's only counting earnings before the month you reach your NRA.
- Starting the month you hit your NRA, your benefits are no longer reduced no matter how much you earn.
- Note: Any reduction in benefits due to the earnings test is only temporary, analogous to "withholding." You will get the money back in the form of a higher benefit at full retirement age, so you shouldn't cut back on working or worry about earning too much
You can estimate how much your annual benefits will be reduced by using the SSA?s . Also see the SSA publication .
Are Social Security benefits taxable?
Your Social Security benefits may be taxable, depending on your modified adjusted gross income (MAGI). As your MAGI increases above a certain threshold (from earning a paycheck, for instance), more of your benefit is subject to income tax, up to a maximum of 85% of your benefit (see below). For details about taxation of your benefits see IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits.
Is it true that nontaxable income (such as Roth IRA withdrawals or municipal bond interest) is included when determining income to calculate taxes on Social Security payments?
Not all nontaxable income is included in the calculation.
Up to 85% of your Social Security benefit could be taxable, depending on your modified adjusted gross income (MAGI). Your MAGI is your regular adjusted gross income plus any tax-exempt municipal bond interest you earned. You don't have to pay federal income tax on the muni bond interest?it's just being included for purposes of calculating the tax on your Social Security benefits.
Roth IRA withdrawals are not included in income for the purposes of figuring the tax on Social Security. But any taxable money you withdraw from a traditional IRA (or convert from a traditional IRA to a Roth IRA) is included in your regular adjusted gross income and so would affect the taxability of your Social Security benefit.
After you calculate your MAGI, add half of your Social Security income to it.
Once you have calculated your income as described above, see the table below to find out what percentage of your Social Security benefit is taxable.
| Filing status | Income | Percentage of Social Security that is taxable |
| Single, head of household, qualifying widower, and married filing separately (where the spouses lived apart the entire year) | Below $25,000 | All Social Security income is tax-free. |
| $25,000 - $34,000 | Up to 50% of Social Security benefit may be taxable. | |
| More than $34,000 | Up to 85% of Social Security benefit may be taxable. | |
| Married couple filing jointly | Below $32,000 | All Social Security income is tax-free. |
| $32,000 - $44,000 | Up to 50% of Social Security benefit may be taxable. | |
| More than $44,000 | Up to 85% of Social Security benefit may be taxable. |
For more information please see IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits.
My wife is two years younger than me, and is the lower-earning spouse. She plans to start collecting Social Security benefits based on her earnings record at age 62. When I start collecting Social Security at age 66, she'll be eligible to collect half of my benefits. Will we be maximizing our total benefits this way?
If you begin collecting Social Security at age 66, your wife will be eligible for 50% of your benefit. But, assuming her is also 66, she would incur a 13.33% penalty because she would only be 64 when you start receiving your Social Security.
A potentially better strategy is the "62/70 split," where the lower-earning spouse begins drawing at age 62 based on his or her own earnings record, and the higher-earning spouse waits until age 70 in order to receive the maximum benefit. Assuming both of you expect an average life expectancy or greater, this strategy will generally maximize your Social Security cash flow over both of your lives. Keep in mind that, once both you and your spouse reach age 65, the odds of at least one of you reaching age 90 are greater than 60%, on average. So, as the higher wage earner, it could make sense for you to postpone benefits for as long as you can, up to age 70.
We recommend that you check with the Social Security Administration to be sure about the details in your particular situation. Meanwhile, the SSA's has some good information about spousal benefits.
As always, if you have questions or need help, please contact your Schwab consultant. If you're not yet a Schwab client but would like to learn more, a Schwab consultant can help. Call 800-435-4000 to get started.
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