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Social Security Once Again Takes a Central Role in Retirement Planning

The only issue remaining is the amount.

Helen Modly, 08/13/2009

Just a few short years ago, clients would tell us to ignore any Social Security benefits in their retirement planning analysis. "I don't expect it will exist 10 years from now," or "I don't want to have to count on it" were some of the comments we heard. Planners often acquiesced because clients presented with such rosy employment forecasts. Three percent to 5% cost-of-living raises annually plus increasing salaries and bonuses of 5% to 10% a year were common planning scenarios. Oh, and remember those investment projections showing linear growth of 6% to 8% year-in, year-out for decades? My first year in the business I actually saw--I won't admit to using--12% linear return projections for variable insurance products.

Those Were the Days
Fast-forward to today's retirement planning exercise where employment is considered as great a blessing as good health, investment returns are playing serious catch-up, and social security has once again become the cornerstone of retirement income.

The primary planning issue concerning Social Security was usually only "how much?" Workers worked, they retired at 65, and they began receiving their Social Security checks right away. Widows usually took their benefits early. Every year they got a little bit of a raise due to cost-of-living adjustments, and that was about the end of the planning implications.

Timing Is Everything
In today's planning, the question of when to begin Social Security is the real issue. For people born in 1955 and later, the actual full retirement age (FRA) gradually increases from 65 to 67 years old. If they begin taking benefits before that, they lose a percentage of their Primary Insurance Amount (PIA), which is the amount they would receive if they waited until reaching FRA. When clients postpone collecting benefits, they will receive an increased benefit based upon how many years they delay (up to age 70) and their year of birth.

Break-Even Point
We used to be concerned about calculating the break-even point, which was the age when the smaller checks clients receive now would be equivalent to the larger checks they would start to receive later. Just a few years ago, this was the primary consideration. In essence, we were asking clients whether they thought they would live longer than age 82 or 84, which were common breakpoints for people whose FRA was age 65. As the FRA has crept up, so has the amount of benefit reduction retirees will see when they begin taking benefits earlier. At age 62, the reduction in benefits is between 25% and 35%, for each and every check for the rest of their life. Widows whose late husbands were eligible can begin taking benefits as early as age 60, but they will also see a steep reduction in benefits.

On the other hand, delaying the start date increases the PIA by 7% to 8% for each year delayed until age 70. This is a huge planning opportunity that is often dismissed without really understanding the implications. By delaying the start date from age 65 to age 70, clients could see their benefits increase by as much as 40% for the rest of their life, plus cost-of-living increases based upon the higher amount.

Keep Working
Most people earn more in their later working years than in their earliest years. The PIA amount is calculated using the most recent 35 years of earnings history, so working an extra few years at a high salary will cause earlier, lower-paid years to drop out of the calculation.

Even if you are already receiving benefits, clients still have planning choices. If they have not yet reached full retirement age, they will see their Social Security benefits reduced by $0.50 for every dollar earned over the threshold of $14,160 in 2009. In the calendar year that full retirement age is reached, the threshold increases to $37,680 for 2009 and the reduction drops to $0.33 for every dollar over. After that, there is no income threshold.

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