The complexities of social security planning unfortunately do not end with the over 2,700 rules which govern retirement benefits or with knowing the 567 possible filing strategies available to a typical couple. Assuming you have survived this mine field of complexity you still have to contend with fully understanding social security terminology. Failure to do so could cost you tens of thousands or even hundreds of thousands of lost benefits that you may have been eligible for.
One clear example is knowing the difference between being "eligible" versus "entitled" for benefits. These terms certainly sound similar but they have a significantly different meaning in the social security world, a strange and confusing world indeed!
One example of where the the difference between "eligible" versus "entitled" could have a profound effect is in divorce benefit planning. For example, if a woman divorced her husband she may be eligible for ex-spousal benefits off of her former husband's benefit amount. She could receive up to 50% of his full retirement age benefit or 100% of his benefit amount if he pre-deceased her. To qualify for these benefits they had to have been married for at least 10 years and both ex-spouses would have to be at least 62 years old when filing for benefits.
If, however, the ex-wife were to get re-married she would no longer be eligible for ex-spousal benefits. As a general rule, re-marriage will nullify receipt of any benefits from your ex-spouse. There are a couple of exceptions to this rule (which I will write about in a future blog) but today I want to focus on an example of how getting re-married and being "eligible" versus being "entitled" to ex-spousal benefits could also profoundly affect your benefits.
Assume a divorced woman is age 66 and collecting ex-spousal benefits off of her ex-husband. Her boyfriend is age 64 and is still working. He too is divorced and is "eligible" to collect ex-spousal benefits off of his ex-wife. He can't do so now because his income is too high and, because of the earnings test, he would not be paid any ex-spousal benefits. He plans to file for these benefits when he turns age 66 and the earnings test no longer applies.
They both, however, would like to get married now but if they did so she would no longer be "entitled" to collecting her ex-spousal benefits and he would also no longer be "eligible" for ex-spousal benefits. As a general rule, re-marriage nullifies ex-spousal benefits. What can they do, if anything?
Here's a possible solution. If they wait until the boyfriend turns 66 and then files for his ex-spousal benefit he will be deemed to be "entitled" to benefits and no longer just "eligible" for benefits. By actually filing for benefits he will become "entitled" and not just "eligible".
Therefore, with both of them now "entitled" to ex-spousal benefits, they could then marry each other and still retain the benefits they receive off of their ex-spouses! This is indeed an important exception to the re-marriage rules.
Here's the code section reference from Social Security POMS "RS 00202.045 Remarriage of a Divorced Spouse- Policy":
"The marriage of a divorced spouse will terminate entitlement to such benefits unless the marriage is to an individual "entitled" to widow(er)'s, mother's, father's, CDB, divorced spouse's, or parent's benefits".
Clearly, knowing the myriad of social security rules and numerous filing strategies is not enough. You also have to be knowledgeable regarding social security terminology in order to maximize social security benefits. Even the most sophisticated social security planning software is not equipped to handle all the nuances and complexities which govern social security planning. Working with a qualified social security specialist may be your best option to ensure you obtain all the benefits you are eligible to receive.
For most workers who pay into social security, their social security tax is based on 6.2% of their earned income up to the social security taxable wage base ($118,500 in 2015). For self-employed individuals however they must also pay the "employer" portion of the social security tax due, which is an additional 6.2% of the social security taxable wage base, for a total tax of 12.4%. Ouch!
Since self-employed individuals know this, they often work closely with their accountant to minimize their income subject to social security tax in order to save on as much of the 12.4% tax as possible. Unfortunately, this is a two edged sword. By minimizing their taxable income they also reduce their eligible social security retirement benefits. This is because your social security benefits are based on your highest 35 years of averaged indexed monthly earnings (AIME). Lower taxable income means lower social security taxes but also lower social security lifetime income benefits.
As self-employed individuals start to approach retirement, however, their focus on saving social security taxes often starts to shift to maximizing social retirement income benefits instead. The realization that their social security benefits may be inadequate in retirement generates many questions regarding what can or should they do to increase their benefits.
Clearly it's a trade off between paying additional social security taxes today in order to obtain higher lifetime retirement benefits. So how can you calculate if the trade off is worth it? As you might suspect, every situation is different. It will depend on what your current benefit is, what it could grow to with higher earnings, when you plan to retire, whether or not your spouse is an employee in your company, spousal (or ex-spousal) benefit options etc. This is no simple calculation and it requires sophisticated social security software but it may be worth the effort.
Let's look at an example. I was approached by a CPA who had a client who was self-employed and worked with his spouse in their business. They were in their sixties and concerned that their social security retirement benefits were too low and wanted to know what could be done. Without going into the full detailed analysis required to fully explain their options let me share some basic options available to them.
By re-allocating a large portion of her income to her husband's income we were able to save on a significant portion of the 12.4% social security tax on her income. Since his income was already above the social security wage base, taking on some of her income did not result in any additional social security tax for him. It also provided them with the same amount of household income.
In addition, since his wife was age 64, and now had minimal earned income, she was able to apply for social security benefits (slightly reduced) and not be subject to the earnings test, which would have otherwise have clawed back her social security benefits.
Since he was age 66 he had reached his full retirement age. He had planned to defer his own benefits until his age 70 however in order to increase his benefits by an additional 32%. (His benefits will grow by 8% per year guaranteed plus any cost of living adjustments). However, since his wife was now able to file for her own benefits early (at age 64) he was now eligible to file a restricted application for spousal benefits and collect 50% of her FULL benefit amount (the amount she would have been eligible for had she waited until her age 66 to file for benefits). He can receive these spousal benefits until his age 70, at which time he will switch to his own higher benefit.
So, to summarize, they were not only able to save on most of her social security taxes while continuing to receive their original total household income from their business but they were BOTH also able to start to receiving income from social security earlier than planned!
If you know the over 2,700 social security rules and have sophisticated social security planning software you may be able to identify similar strategies applicable to your own situation. If not, it may be worthwhile to work closely with a social security planning specialist, as well as your CPA, to review all your options available to you to minimize social security taxes and maximize social security retirement income. This could represent tens of thousands or even hundreds of thousands of additional income in retirement that you may otherwise leave on the table.
Did you know that the benefit amounts shown on your social security statement may be incorrect? The reason for this is that every statement merely provides an "estimate" of your potential benefit amounts. They do not show your guaranteed benefit amounts or even your minimum benefit amounts. Just estimates.
The Social Security Administration, as detailed in your statements, records your historical earnings record from data they obtain from your tax returns. They then calculate your benefit amounts based on your "highest 35 years of averaged indexed monthly earnings (AIME)". To do so they look at your actual earnings history and then "estimate" your future earnings by taking your last full year of earnings and use that value as your projected annual earnings until you reach age 70.
In addition, they do not index your earnings for cost of living (COLA) after your age 60, even though they will do so when you eventually file for your actual benefits.
As a result, the benefit amounts you "actually" end up receiving from social security is likely to be somewhat different, and possibly materially different, than the estimated values on your statement. The amount of the difference can vary from a few dollars per month to hundreds of dollars per month.
For example, I had a very successful high earning client who was age 57 and planned to stop working at age 58 and not draw on SS until at least age 66. Her SS statement clearly over stated her estimated benefit at age 66 because social security assumed, on her statement, that she would continue to earn her high income each year until she reached age 66. When I "re-calculated" her estimated benefits, it ended up being $111,000 less in lifetime benefits than shown on her social security statement. This had a material impact on her overall retirement income planning.
I had the opposite result with a divorced client of mine. She divorced in her late 50's but then returned to work. Although her income started out low it continued to gradually increase each year. When I incorporated her estimates of her future income (not the one used by social security) I was able to show her that she could now plan to file a restricted application at her age 66 and defer her own benefits to age 70, in order to earn delayed retirement credits. Her own social security benefit would then grow to more than half of her ex-spouse's benefit. She could then switch to her own now higher benefit. This increased her expected income in retirement by over $60,000.
Again, had she assumed that the estimated benefits on her social security statement were correct, she never would have thought to file a restricted application. This is because her estimated benefit was less than one-half of her ex-spouse's benefit and was estimated to remain that way throughout her life. In this case, an incorrect estimated income on her social security statement had a profound effect on her anticipated retirement income.
Lastly, it is important for everyone to check the earnings history as shown on their SS statement versus their own earnings records. It is not uncommon for social security to have incorrect earnings information. One of my clients, who happens to be an accountant, found that social security had recorded zero income for him for five consecutive years in which he was actively employed and earning substantial income. He is currently digging up old tax returns to rectify the situation with social security.
Even if your earnings history is correct, the only way to get a more accurate estimate of your social security benefits is to use sophisticated social security software that will allow you to "re-calculate" your benefits by incorporating both past earnings and your own estimates of future earnings, as well as an assumed inflation factor.
Clearly it is critical not to rely on the estimated benefit amounts shown on your social security statement. First double check to see if the annual income figures shown on your statement are correct. Secondly, recalculate your benefits using your own estimated annual income projections or seek the assistance of a qualified social security expert to re-calculate your benefits for you. It could have a profound impact not just on what your actual social security benefit amount will be but it could also affect your decisions regarding the best time to file and the best way to co-ordinate your benefits with spousal or ex-spousal benefits.
Married, divorced, single, re-married...does your marital status really affect your potential social security benefits? Absolutely! Not knowing how design a social security income strategy based on your marital status (or future martial status) can have a significant affect on your lifetime benefits.
With the divorce rate still at about 50% for first marriages, the need for divorced spouses to do planning is very important and requires an in-depth understanding of the social security rules. If a divorced spouse is considering re-marriage, then the timing and co-ordination of benefits between the divorced person, their ex-spouse and future spouse is even more important.
For example, I had a client who was 61, divorced (was married for over 20 years and divorced for over 2 years) and is now in a new relationship. She was given an analysis of her expected social security benefits from her divorce attorney. She came to me to find out how to best co-ordinate her benefits "if" she was to get re-married in the future. Since her former husband was the primary income earner in their marriage, his social security benefit was about twice hers. Her new boyfriend's benefit was similar to hers. So, what were her options?
At her full retirement age (66) she would be eligible to collect 50% of her ex-spouse's benefit. To optimize her lifetime benefit, I suggested that she take her ex-spousal benefit at age 66 until her age 70 and then switch to her own, then higher benefit. I also let her know that she would be eligible to receive his full benefit if he were to pre-decease her.
But what if she were to get re-married? Basically, as soon as you re-marry you lose all benefits off of your ex-spouse. Therefore, she would lose her ex-spousal benefit immediately upon re-marriage. She would still be eligible to receive a survivor benefit off of her ex-spouse (even if she re-marries) because she would have re-married after the age of 60. (yet another exception in the quirky social security rule book).
If she married her boyfriend, she would then be eligible to collect a spousal benefit off of his benefit once she turned 66 and assuming he had already filed for his benefits. She would also have to be married for 12 months before she could collect a spousal benefit off of her new husband. One exception to the 12 month rule is if she was already collecting ex-spousal benefits when she re-married. In that scenario the 12 month rule would not apply. (once again, another crazy and little known exception in the social security rule book!)
So, what would it cost her in lost social security benefits to get re-married before her age 66? In her particular case it would cost her a minimum of $40,000 from ages 66-70. That's the difference between her ex-spousal benefits and spousal benefits off of her new spouse. If she waits until age 70 to get married then she could collect the $40,000 of additional benefits off of her ex-spouse and then switch to her own benefit at age 70.
This is just an example of how social security benefits can be affected by re-marriage. When analyzing the affect of re-marriage on social security benefits, one must look at a number of factors for all three parties involved including their ages, benefit amounts at full retirement age, the date of re-marriage, who has filed for benefits and when, is it a second marriage for one or both spouses, past earnings records and future expected earnings and a number of other factors.
It's not a simple analysis and often requires a custom solution. However, given the importance of social security retirement benefits, especially for divorced individuals, it is imperative that all options be considered in order to maximize potential benefits.
Ash Ahluwalia, NSSA, CCSCA, MBA