Social Security Retirement Benefits – Read the Fine Print

June 3rd, 2019 by Jim Allen

Social Security retirement benefits are an important part of most people’s retirement income plan. In fact, according to the Social Security Administration, it often accounts for 40% or more of a retiree’s income. Social Security provides some very important benefits to retirees: it is guaranteed for life (plus your spouse’s if married), it provides a cost of living adjustment so it keeps up with inflation, and it is backed by the United States Government. The rules for claiming Social Security are also extremely complex and a wrong decision can result in leaving tens (if not hundreds) of thousands of dollars on the table. Our blog this week covers three of the “fine print” traps you need to be aware of before making your Social Security claiming decision.

• Permanent reduction in benefits if you claim too early. Social Security has a concept called “Full Retirement Age” which is the age they expect you to retire and turn on your benefits. This is age 66 to 67 depending on the year you were born. However, the rules allow you to turn on Social Security retirement benefits as early age 62. This is often an attractive option for people who want to get as much benefit as they can, are concerned Social Security won’t be around in the future or are planning on or forced to retire earlier than full retirement age. But, here’s the fine print on taking it early: your benefits will be permanently reduced up to 25% to 30% depending on how early you take it. For example, if your benefit at a full retirement age of 67 is $2,000 per month, at age 62 the benefit would be reduced to $1,400 per month. Taking it early may still make sense depending on your situation, but that permanent 30% per month reduction over 25-30 years of retirement adds up to a lot of money left on the table.

• If You Claim Benefits Early and Continue to Work, Your Benefits Will Be Reduced. Another of the fine print traps of taking benefits early is “the withholding rule”. This rule stipulates that, if you turn on benefits prior to full retirement age and continue to work, your benefits will be reduced by $1 for every $2 you earn. However, there is an exemption allowed for wages earned below a certain threshold ($17,640 in 2019). Say for instance, you are age 64 and have a Social Security benefit of $24,000 per year but are also still working earning $40,000 per year. Your benefit will be reduced by $11,180 due to this rule. So, your net benefit would only be $12,820 which is a 46% reduction in Social Security income. The rule is more complex than outlined here, but it is important to consider the fine print on working and claiming early before deciding to do so.

• Social Security Benefits are Taxable at Certain Income Levels. While not a Social Security rule, but an IRS rule, this is another “gotcha” that people turning on Social Security are not aware of. Generally, if you have a “modified adjusted gross income” or “MAGI” of more than $25,000 as a single person or $32,000 as a married couple, then 50% of your Social Security benefits will be included in your taxable income. The amount included in taxable income increases to 85% if your MAGI is more than $34,000 single or $44,000 married. Now many people will automatically have incomes above the threshold for paying tax, regardless of whether any planning can be done. However, careful tax planning is required if you are near the thresholds. For instance, if you have a MAGI of $24,999 (as a single person), none of your Social Security benefit would be taxed. However, if you have a MAGI of $25,001 (as a single person), now 50% of your Social Security benefit is taxable. So, a $2 swing in MAGi caused $12,500 of your Social Security benefit to be included in your taxable income.
At Anchor Bay Capital, we specialize in helping pre-retirees plan their dream retirement. Part of that planning is to provide expert advice in the area of Social Security. Our comprehensive planning approach includes coordinating all areas of retirement income planning including: Social Security, investments, tax planning, retirement income and estate planning. If you would like a complementary Social Security analysis, please contact us.