This post is a follow up to Social Security Game Changer: Bipartisan Budget Act 2015, which discusses the history of Social Security optimization strategies, the new rules and important planning caveats. This post explores Social Security strategies for an example client not eligible for either a File and Suspend Strategy or a Restricted Filing Strategy. For those who are not eligible for either of the above strategies this does limit the Social Security optimization tools available, but it does not eliminate them. Below are some of the strategies that remain available. In addition to these, it is still important to know the break-even age when delaying benefits provides for more life-time income, and results in a higher asset balance than having claimed benefits earlier.
The first strategy to consider will likely become the most common as it can be applied to the most individuals. Since the “deemed” rules only apply if an individual is eligible for both spousal and their own benefit then it is possible to claim your benefit before you become eligible for spousal, and take a “bump-up” to your spousal benefit later. This is almost a reverse of the nearly eliminated File and Suspend strategy.
Here’s an example:
Jane’s Age = 61
Bob’s Age = 60
Jane’s FRA benefit = $2,000
Bob’s FRA benefit = $500 (in order to receive this benefit Bob must wait until he is 66 and 2 months old)
Note that Options 1 and 2 are very similar in monthly benefits, but Option 2 ultimately has $30 more each month and thus without indexing the income stream breaks even with Option 1 at Jane’s age 84. Option 3 has no income for a few years while Options 1 and 2 are collecting, but then the eventual monthly benefit is $640 more than Option 1 and $610 more than Option 2. Option 2 starts benefits the earliest, and has a slightly higher monthly benefit that Option 1 once fully in swing, this results in Option 2 breaking even with Option 1 at Jane’s age 81. Because of the major increase in monthly benefits the income stream without indexing for Option 3 breaks even with Options 1 and 2 at Jane’s age 84.
The distinction of “without indexing” is important because the compounding of a Cost of Living Adjustment on a higher monthly benefit amount is greater than it is on a smaller benefit. In other words increasing $3,000 by 1% a year is a $30 increase the first year, and a 1% increase on $3,640 is a $36 increase. That’s not much to start with, but in 30 years the difference is more pronounced with $3,000 increasing by $1,043 and $3,640 increasing by $1,266, or a little over $2,500 annually. Even this conservative assumption for the Social Security COLA going forward means that Option 3 breaks even with Options 1 and 2 at Jane’s age 82, or two years earlier than with no COLA.
The final way to compare these strategies is to include the benefit streams in a full retirement projection and compare the resulting capital balances. The following comparison assumes the clients have $1,000,000 in a taxable equity account earning 6% appreciation before taxes at the start of the plan. The clients are assumed to already be retired and to be spending $50,000 per year, not including taxes, inflating at 3.5% annually. The taxes are made up entirely of capital gains, and the client lives in Oregon, where capital gains are taxed at the same rates as income (9% roughly).
As you can see graphically, the reduction in the asset balances caused by waiting to file in Option 3 makes it so that this strategy never catches up to the others in this situation. This is the impact of the opportunity cost of losing that 6% return on assets early in their retirement. In this case Option 2 surpasses Option 1 at Jane’s age 82, similar to when the cumulative income surpasses the income from Option 1 as well. When comparing these three strategies the ending capital ranges between $1,300,000 and $1,370,000.
If we run the same case with one of the individuals dying at age 80, with the survivor spending 80% or $40,000 in today’s dollars, and do the same analysis we get the following three charts.
Option 2 exceeds Option 1 at Jane’s age 81 Option 3 breaks-even with Options 1 and 2 at Jane’s age 83 without a COLA applied.
Option 2 exceeds Option 1 at Jane’s age 81 and Option 3 has the most cumulative income at Jane’s age 82 when a 1% COLA is applied, or one year earlier than with no COLA.
Finally, when looking at the retirement capital for this case, Option 2 exceeds Option 1 at Jane’s age 81 while Option 3 never catches up with either of the other options. The ending capital for these scenarios range from $1,390,000 to $1,530,000, a $140,000 difference, much more pronounced that when both clients live to age 95.
Knowing when a client is going to die is the only way to guarantee that they select the optimal Social Security strategy for their situation, and lacking that, knowing their health history and family history will at least help make informed assumptions. In the above examples note that the three strategies compared end with capital at end of life within $150,000 of each other. This shows how the recent changes to Social Security have lessened the impact that Social Security planning can have, but it has not completely removed the advantage of it. You can also see from the above examples that the Social Security strategy that results in the highest cumulative income over the life of the clients is not always the “optimal” strategy.
Please let us know if you find this helpful by adding a comment to this post and we will continue to create example case studies.
This is a follow up article to Social Security Game Changer: Bipartisan Budget Act 2015, which discusses the history of Social Security optimization strategies, the new rules and important planning caveats.
