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By Christine Benz and Mark Miller | 10-11-2012 12:00 PM

Avoid These 3 Social Security Pitfalls

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.

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