Last submission we discussed the cancellation of the two most popular Social Security planning tactics, File-and-Suspend and Restricted Claims, effective April 29, 2016. After we investigate the impact of these changes on divorced and survivor spouses, we will focus on the nature of planning going forward.
The new law impacts Social Security claiming rules for divorced couples—
- Filing a restricted application at Full Retirement Age (FRA) to obtain the ex-spouse’s spousal benefits (as long as the ex-spouse is at least 62 and whether or not that person had filed for benefits) has been an effective strategy to maximize individual retirement benefits (through deferring them), while obtaining at least some (ex-spouse) benefits along the way.
- This version of the “claim now, claim more later” strategy remains available under the new rules, but only for those born on or before January 1, 1954. They can still claim spousal at FRA and delay filing for individual retirement benefits until later.
- For those born after January 1, 1954 there will no longer be an option to delay the individual benefits while claiming an ex-spouse’s spousal benefit. Whenever they claim Social Security, they are deemed to file for both individual and spousal benefits and they will be paid the highest benefits to which they are entitled, whether on their earnings or as a spouse.
New Rules Do Not Impact Survivor Benefits—
- When one member of a married couple dies, the survivor is eligible for a survivor’s benefit (a widow/widower’s benefit), equal to 100% of the deceased spouse’s benefit. The rule also applies to a divorcee whose former spouse has passed away, as long as the marriage lasted at least ten years and the divorcee has not remarried prior to age 60.
- As with any benefit, if the surviving spouse claims multiple benefits, such as a widow’s benefit and his/her own individual retirement benefits, only the higher of the two is paid.
- Under the new rules, the surviving spouse still has the flexibility to begin widow’s benefits as early as age 60 or as late as FRA, and can also choose whether to start his/her own retirement benefits as early as age 62 or as late as age 70.
Future Social Security Planning—
- The new law takes away the two most useful tactics that favored the delaying of filing for full Social Security benefits until age 70.
- Social security’s rules are designed to be actuarially fair, meaning that the 8% credits for delaying (and 8% penalties for early filing) should provide roughly the same lifetime income, according to the actuarial tables.
- Given today’s interest rates, the 8% credit is a great deal. These rules were written in the 1980s, when market interest rates were much higher, so you had to pay people more for delaying their benefit. Since people are living longer, they are likely to get more years at the higher benefits.
- The new optimal filing strategy will focus on a break-even analysis– how many years both spouses must live to make up for the foregone benefits of a delayed filing. The longevity hurdle will be higher because of the significant benefits that File-and-Suspend or a Restricted Claims delivered to a deferring filer. Under the old rules, the break-even age might have been age 82 and now it might be 87.
- Because none of us know how long we will live, we could think of a year of foregone benefits as an investment in a longevity annuity with an eight percent payout. This delivers a higher Social Security benefit, with a cost-of-living adjustment, in later years, when other savings may have been spent.
- File-and-Suspend and restricted claim filings were complex mechanically, but they provided a significant financial benefit. Now, with fewer and simpler Social Security tools available, retirement planning overall will be more complex. The question becomes, how can other retirement vehicles be used to replace these removed tools, in order to provide for a phased retirement process and maximum lifetime benefits?
A pessimist might argue that up to $65,000 in additional Social Security benefits have been taken off the table by Congress and must, therefore, be replaced through other retirement vehicles. While these changes were designed to close a loop hole for the incredibly rich, one wonders whether it might have more impact on middle class, dual-income couples striving to maximize Social Security benefits to maintain their lifestyle. Is this the much-heralded solution for the under-funding of our Social Security/ Medicare system or simply more income redistribution?
Remember, it’s not what you make that matters…it’s what you keep!
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties. Please seek advice from an independent tax advisor before acting on any information presented.