Thu, 11 Oct 2012
Retirement expert Mark Miller urges pre-retirees to be mindful of how age, Medicare, and spousal strategies all interplay with Social Security benefits.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. By not properly managing Social Security benefits, seniors may forgo thousands of dollars over their lifetimes. Joining me to share three common pitfalls in Social Security is Morningstar contributor Mark Miller.
Mark, thank you so much for being here.
Mark Miller: My pleasure.
Benz: Mark, you say one of the key pitfalls associated with Social Security is that people don't spend enough time calibrating what is the optimal time to start receiving benefits. Let's talk about that one.
Miller: Yes. It's important to say there is no one-size-fits-all answer here. It really can vary by situation, but it's important to be aware of the impact of a decision to file early, to file at the full retirement age, or to file beyond. So, your Social Security benefit is determined by a formula called the primary insurance amount, which is a complex Social Security formula for averaging your lifetime earnings, which is in turn what drives what you get from Social Security in the way of benefits. So, to give you an idea of the order of magnitude of the impact of these decisions, the current full retirement age is about 66. If you file at 66, you get your full 100% of your benefit. If you file at 62, which is the first age you could file, you would get 75% of your monthly benefit.
Benz: There is a lot of data showing that people do file right at 62.
Miller: Many do. At least half of Americans do file early, and there can be good reasons for that. There could be an acute financial need; there could be a sense that their longevity is not going to be great. I'm not saying that's never the right thing to do, but it's just to be aware that your monthly benefit resets down to 75% of which you could be getting by waiting until 66. And then on the other side of that coin by waiting until 70, you would get a 132% of your monthly benefit. There is no point in waiting beyond 70 because the extra credits stop accruing at 70. So, that's the range you're looking at, 62 to 70. The rationale for waiting I would like to say think of it as buying yourself a high-yielding inflation-protected annuity.
Benz: Good luck finding that right now, right in the marketplace.
Miller: Good luck. You even might find it, but it's going to be darn expensive. And as we know annuities are not yielding much now because of the ultralow interest-rate environment. Social Security benefit formulas are not predicated on interest rates really. So, that's a big plus and the fact that you get the annual inflation increase, which also starts to really compound. Think about that 62 versus 66 or 70, what's that cost of living adjustment going to be computed against? You really take advantage of the power of Social Security by waiting if possible.
There's even been good research to suggest that a good strategy can be paying for that delay if you need to by even drawing down from portfolio assets in the short term to pay for living expense. That's actually an excellent portfolio-protection tool down the road because you're getting so much higher Social Security benefits later on that it reduces that need to withdraw as much from your portfolio.
Benz: Even though filing later can yield some powerful benefits, you say that those late filers need to be aware of another pitfall. Let's talk about that one.
Miller: That's the Medicare pitfall. If you're enrolled in Social Security at age 65, you are automatically enrolled in Medicare, and you'll receive your Part A and Medicare card, which is the hospitalization. If you're not enrolled in Social Security at 65, you have to take the active step of enrolling, and here is the pitfall. If you're not enrolled at 65 and within a certain window of your 65th birthday, you start getting penalized for every year of delay, basically for every 12 months of delay past 65 for Medicare enrollment. It's a 10% penalty on your premiums that you'll pay in Part B, lifetime for every 12 months.
Benz: So, that never goes away.
Miller: No, it's permanent. And let's say, you made the mistake of waiting five years. You didn't enroll to Medicare until 70. You'd now be looking at a 50% lifetime increase. I mean it's just its painful. So, this is not a pitfall that you want to fall into. You want to make sure you enroll. The only exception is for people who are still working at 65 under certain situations can be exempt from enrolling for Medicare if they are still covered by employer insurance. Medicare is still the primary insurer at age 65, if you're working.
If you work for a small business, with fewer than 20 workers, other than that, you can have an exemption from filing, but even there it's important to be careful. Make sure you have paperwork that you've notified Medicare that you're delaying. Some people even advocate going ahead and signing up for Medicare Part A, which is hospitalization, anyway because there is no premium attached. And then you're safe, you know you're in the system at age 65.
Benz: Very little downside to it.
Miller: Very little downside to it, and you avoid what could be a big downside.
Benz: Let's talk about the final pitfall--that has to do with spousal and survivor benefits. What should people be mindful of there?
Miller: Right. For couples, it's important to think about Social Security as a couples strategy, and sometimes people fail to do that and kind of have the blinders on it and think instead about their own benefit. But Social Security has really powerful spousal features that are important to be aware of, both spousal and survivor. The survivor benefit is the most simple to understand, which is that a surviving spouse can step up to a 100% of the deceased spouse's benefit in cases where that makes sense. That can be important because now the household has gone from two Social Security payments to one, but at least you can step up to 100% of the higher one if that's appropriate to do so.
And then there can be situations with different spousal strategies. So, this involves where one spouse has a significantly higher earnings history than the other over the course of a lifetime and is entitled to a higher benefit. So, one that's fairly well-known is the file-and-suspense strategy, where the higher earner goes ahead and files for benefits at his or her full retirement age, but then immediately suspends payments. That permits the lower-earning spouse to step in and file for a spousal benefit.
Benz: And get half of that.
Miller: And get half, assuming that spouse is also at full retirement age. You can file below that age, but then you'll receive a reduction for that. So, if you filed for the spousal benefit, you can get half of the spouse's [benefit] to start having Social Security coming in, while the higher-earning spouse delays the filing to accrue additional benefits perhaps to 67, 68, or even 70. So, that's the file-and-suspend method.
The other one is a little less-known, some people jokingly refer to it as "claim now, claim more later." Here, the higher-earning spouse delays filing for his or her own benefit and instead files for a spousal benefit for the lower-earning spouse, again just as a way to get some Social Security income coming in the door.
Benz: Maybe as early as age 62 for that?
Miller: You could do at your full retirement age, let's say 66, and whatever the spousal benefit that's available, you could take that.
Benz: So, you're taking the spousal benefit for a period of time. Then at some point…
Miller: File for your own.
Benz: File for your own.
Miller: They are all really versions of the same notion of delayed filing but get some money coming in the door short term.
Benz: So, the idea is to get the biggest bang from that?
Miller: Yes. It's a way of looking at lifetime bang for the buck.
Benz: Mark, obviously there are a lot of different factors to consider here, but thanks for sharing some of the key pitfalls to avoid in Social Security.
Miller: Thank you, Christine.
Christine: Thanks for watching. I'm Christine Benz for Morningstar.com.