Wed, 9 May 2012
'Restricted application' and 'file and suspend' are two techniques spouses can employ to ensure they get the most out of their Social Security benefits, says Michael Kitces of Pinnacle Advisory Group.
Christine Benz: Hi, I am Christine Benz for Morningstar.com. The timing for a retiree's receipt of Social Security benefits can have a big impact on his or her lifetime benefit, and that's particularly true for married couples.
Joining me to discuss some research in this area is Michael Kitces. He is a partner and director of research at Pinnacle Advisory Group. Michael, thank you so much for coming in.
Michael Kitces: Thanks, my pleasure. Happy to be here today.
Benz: So Michael, this is a hot topic among our readers. They really would like guidance on how to maximize their lifetime Social Security benefits, but this gets complicated, when you've got married couples maybe who have a big age gap between them or a big income/earnings gap between them. Let's discuss some general rules of thumb. If you're part of a married couple and you're trying to figure out the timing of the receipt of these benefits, what are some pieces of guidance that you can give people?
Kitces: Absolutely. The starting point around these decisions, obviously, at the most basic level, it's essentially, "Do I take [Social Security] now, or do I delay it?" And in the individual context, that's relatively straightforward. If I delay, there are certain payments I won't get now in exchange for getting higher payments in the future. The higher payments in the future make up the money I didn’t get early on, and we can kind of do the math. There is a break-even period. If you live this long, you'll make up the payments. If you live longer you come out ahead. If you don't make it that long, you came out a little bit behind.
With married couples, it gets more complex because of the crossover the benefits decisions can have on each other, and so when we look at rules like for a widow, you get the higher of your benefit or your deceased spouse's benefit. Well, now when we're looking while everyone is still alive, at what that first spouse should do, decisions to delay one person's benefit affects not just that individual, but potentially also the survivor benefit of the other person after the fact.
Now what that generally leads us to, at least in terms of a rule of thumb, is it makes the delayed decision an especially good deal for particularly the higher earner because now in essence the delayed decision really means our break-even is the longer of my lifetime for having delayed or my spouse's lifetime if my spouse outlives me. It's a lot easier to get to those break-even points when we have two life expectancies instead of one in order to get there.
Sort of the starting-point emerging rule of thumb is we delay the higher earner's benefits as long as possible, even if that person themselves is unhealthy because we can still get to the required time horizon for the surviving spouse. And then if we're delaying the higher earner's benefits, now we start looking at anything that we can do to try to get some money out of the system during basically our 60s, because the maximum delay age is 70. What can we do to get money out of our benefits during our 60s until we get to that age 70 point where the higher earner turns on the higher benefit?
Benz: Well, let's discuss a strategy or two around that idea. Say that you have decided to wait until age 70 for that higher earner; what is a way to bring out some benefit up until that point.
Kitces: Well, great question. We see two primary strategies that emerge and it sort of depends on exactly where the spouses' benefits are relative to each other. The first one that we see is one of the rules that Social Security gives us is what's called a restricted application, which means, I'm going to apply to get my spouse's benefit now, but I'm restricted to only getting my spouse's benefit and not my own personal benefit. The opportunity we see is for that higher-earning spouse to say, "I'm going to start my spouse's benefit now get payments for a couple of years and then when I finally reach age 70, step up to my own benefit. So, I get my spouse's benefit free for a few years and then I still get the same personal delayed benefit that I was going to all along."
The important caveat to that strategy in particular though is you can't do a restricted application until you actually reach your own normal retirement age. So, for most folks today that's going to be age 66, if they are in the window for Social Security right now. It means we can't start this strategy at 62; we've got to wait until 66. But we can get a spouse's benefit at 66, until we turn 70; then we bump up to our own. We essentially have an opportunity to double dip to the system: a spouse's benefit and then our higher personal benefit.
Now the opportunity we see sometimes is the order flips around, and so instead of having the higher earning individual take spouse's benefits first, we have the higher-earning individual do what's called file and suspend, which means they turn on the opportunity for a spouse to get spousal benefits while they keep suspending their own benefit and they let the spouse start benefits early while still delaying. So, we essentially say you know what even though we're going to delay my benefit until age 70, my wife can start her benefits early as a spousal benefit of mine.
Then at some point down the road, if I passed away first, she’ll step up to mine. If I don't, either at worst she continues her spousal benefit or at best, she may now delay her own benefits, step her own benefit up until she is 70, and then advance forward with her benefit from there. We see that sometimes we can even do this simultaneously. I start some money for my spouse, while I am delaying to 70, and my spouse takes that until she turned 70. Then we both step up to our age 70 benefits. The caveat for that strategy again, as with restricted applications though, is that I cannot file and suspend until I reach normal retirement age.
Although really we can start benefits any point along the spectrum, most folks tend to think of it as a kind of a binary thing, either I'm going to start early in which case, I may as well go early as possible and start at 62, or I may as well delay in which case I’ll delay as late as possible and go to 70. We see the overwhelming number of folks basically trying to decide whether they start at 62 or 70.
What these strategies really introduce is that there is really a third key point which is that line where I reach normal retirement age, where I can began file and suspend to turn on my spouse's benefits, and where I can do a restricted application so I can take my spouse's benefits for myself. So, we really see now three decision points and obviously you can still pick anywhere between the lines as well, but we really see three primary decision points, 62, full retirement age , and then age 70.
Benz: So obviously there are a lot of different factors floating around there.
Benz: And so it seems that retirees may want to try to get some guidance on this issue, obviously there are financial advisors who focus on this area of planning. Are there any online resources that you like. I know the Social Security website has some tools.
Kitces: Yeah, the Social Security site has some tools, but unfortunately their tools are more geared around telling what your benefits are and what you're going to get. In fact the Social Security Administration just in the past week or two has come out with their new online statements. You can actually get your benefits estimates, your earnings history, and see all of that information, but that's just really what you're going to get. It doesn't really help you plan around which ones are better. We see a number of Web-based tools coming forth now that give us some opportunities to really analyze the different permutations.
So, things like, ssanalyzer.com, socialsecuritytiming.com, maximizemysocialsecurity.com. These are all sites with some pretty robust tools and analytical work behind them to try to help figure out--when we look at all the different benefits and all the different options and we make whatever assumptions we want about whose is going to live how long--which combination of stuff really fits together best.
We can sometimes get some surprisingly counterintuitive conclusions, whether it's the particular combination of ages and benefit levels that mean if they are this far apart we want this person to file and suspend and this person to get a [spousal benefit] but if they're are a little further apart, we want this person to start and this person to file a restricted application. As ages gap out, we get even different strategies. Things like it may become especially appealing to delay a higher earner's benefit until age 70, but if the ages are far apart, the odds unfortunately are pretty good that by the time the younger spouse is even ready for any benefits, the older spouse is probably a little closer to mortality which means we're about to step up to a survivor benefit. So, we may actually see a much, much younger spouse file for an early benefit as quickly as possible because the goal is just to get a few dollars in before stepping up to a higher survivor benefit down the road.
So the permutations start to get a little bit complex when we merge them to all together, though again that driving rule of thumb that we're starting to see really consistently is to delay a higher earner's benefit as long as possible and then do whatever we can in the earlier years to fill in any dollars for either spouse until we get [to the point when the higher earner begins taking benefits], especially when we look at what happens when you outlive those time horizons.
Social Security sort of comes out to be what I now call a triple hedge. It hedges our longevity because by definition the longer we outlive our life expectancy, the better the delayed deal was and of course that means we're getting the biggest bang when we need it. It proves to be an effective inflation hedge because Social Security benefits are adjusted for inflation unlike almost any other return out there, or at least we sort of hope the returns will adjust with inflation in the future. But it is not written into the deal the way that Social Security is.
And indirectly you'll find Social Security becomes a hedge against bad markets, as well because it's an income stream that continues to stay steady, is guaranteed, and rises for inflation along the way. As the returns gets worse, it actually makes the break-even points easier and gives us even more upside on the back end to help make up for a portfolio that did poorly. So, what we're really seeing is that the pressure is on to delay [benefits], especially when we can fill in benefits [for people in their] 60s with at least partial amounts as we go.
Benz: Well, Michael, thank you so much for sharing your valuable insights into this very important area of retirement planning. We appreciate you being here.
Kitces: Happy to be here, I hope it's helpful.
Christine Benz: Thanks for watching. I am Christine Benz for Morningstar.com.