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Mark Miller: Remaking Retirement

Social Security and Medicare: Proper Planning Pays Off Big

Smart navigation of the complex rules around these critical retirement programs can mean thousands of dollars in higher benefits and cost savings for seniors.

What you don't know about Social Security and Medicare can hurt you.

Both of these critical retirement programs have complex rules governing when you file for benefits, interaction with employment, and spousal and survivor benefits. Any one of these factors can make thousands of dollars of difference to seniors in lifetime benefits or costs.

At last month's Morningstar Individual Investor Conference, I shared the stage with one of the nation's top experts on the Social Security and Medicare--Mary Beth Franklin of Investment News. We spent an hour discussing the latest trends on both programs. ( Premium Members can watch a replay of the conversation by  clicking here.) Here's a rundown of key points to remember when navigating the sign-up process as you approach retirement age.

Social Security
About half of all Americans file for Social Security when they first become eligible for benefits, at age 62. Most would be better off waiting because benefits are increased for every year that you wait, up to age 70.

But there's no one-size-fits-all solution. Some who have suffered a job loss in the recession have a compelling need to replace income as soon as possible; others decide to file early if they have reason to think they won't live long. "Waiting is [better] for many people," Franklin noted at the conference. "However, if you're in poor health, you may want to take benefits early, at 62."

Social Security's filing rules are built around the program's full retirement age, or FRA (currently 66). The idea is to ensure that Social Security pays out fairly among all beneficiaries, no matter what age you file. Monthly benefits for earlier filers are reduced accordingly to avoid paying them higher lifetime benefits.

However, a focus on lifetime benefits misses the point. Social Security is intended as a source of guaranteed income to meet living expenses no matter how long you live. Most seniors will do better making a choice that boosts their monthly payout.

Under the rules, annual benefits are reduced for most of the years you start early, based on an actuarial projection of average longevity. For a 62-year-old filing this year, the net effect will be a 25% permanent reduction of annual benefits. On the other hand, your benefit will be bumped up by 8% for every year that you delay filing beyond the FRA up until age 70, after which credits for waiting no longer are awarded. You can run what-if projections on what you would receive using the Social Security Administration Retirement Estimator or the AARP benefits calculator.

Moreover, if you have income from wages in your 60s, it makes little sense to file early for Social Security. Earlier filers are hit with a penalty on income of more than $14,640. (Social Security defines "income" in this context as wages from employment or net earnings from self-employment). If earnings exceed the limit, $1 will be deducted from benefit payments for every $2 earned over that amount. The withheld benefits are added back into benefits after the senior reaches the FRA. After reaching your FRA, you can have an unlimited amount of income and receive Social Security benefits without penalty.

Married people sometimes put on the blinders when it comes to Social Security. That's a mistake because the program rules include important benefits for spouses and surviving widows. The survivor rules permit widows to receive up to 100% of a deceased spouse's benefit or her own benefit, whichever is greater; the spousal rules permit receiving the greater of her own benefit or up to half of a living spouse's benefit.

The upshot of the survivor rule: Couples usually benefit when the spouse with the higher lifetime earning history (which translates into a larger Social Security benefit) delays filing. That's most often the man--and men can expect their wives to outlive them. A delayed filing by the higher-earning husband usually sets the stage for the widow to receive a higher benefit down the road, after his death.

"I think of couples . . . in an 'Ozzie and Harriet' type scenario, where the husband has been the main breadwinner and the wife may have had little or no earnings over her lifetime," Franklin said at the conference. "In that case, it probably makes sense for the wife to claim benefits early at 62--it brings some money into the household--and for the husband . . . to delay until age 70. That's great for the husband getting the bigger benefit, but more importantly, it's making sure that if he dies first, which is actuarially likely, he is ensuring the highest survivor benefit possible for the wife."

Divorced people also can qualify for a spousal benefit based on the ex-spouse's wage history if they meet certain criteria.

Another strategy that can pay big dividends is known as a "file and suspend." In this situation, the higher-earning husband wants to continue delaying taking benefits past his FRA in order to keep accruing credits. But the lower-earning wife would like to file for spousal benefits on the husband's record.

Here's how it works:

  1. The higher-earning spouse files for benefits at his FRA but immediately files a notice to suspend benefits.
  2. The lower-earning spouse elects to receive spousal benefits
  3. The higher-earning spouse continues to accrue higher payments for whatever point he elects to begin receiving benefits. 

Once upon a time, Medicare eligibility coincided with Social Security's full retirement age. But that began to change with the Social Security reforms enacted in 1983, which began to push the FRA higher.

Medicare eligibility still begins at 65, and sign-up is automatic if you're already receiving Social Security benefits. If not, it's important to sign up sometime in the three months before your 65th birthday up through the three months following. In fact, failing to do so can lead to expensive premium penalties.

Monthly Part B premiums jump 10% for each full 12-month period that a senior could have had coverage but didn't sign up. That can really add up: a senior who fails to enroll for five years ultimately would face a 50% Part B penalty--10% for each year.

Often, you can delay starting Medicare without penalty if you're still employed when you turn 65. Medicare is the primary health insurance payor if you work at a company with fewer than 20 employees; at larger companies, the employer's coverage is primary. In the latter situation, a senior can postpone filing for Parts A (hospitalization) or B (outpatient services), though many choose to enroll for Part A anyway because it doesn't require premium payments. Seniors can enroll later on without penalty for up to eight months following retirement.

If you do opt to postpone enrollment, it's wise to notify Medicare at age 65 of your decision in order to ensure that there won't be problems with premium penalties at a later time. This can be done by checking off a box on the back of a Medicare card that has been sent, by calling the Social Security Administration, or by going to the SSA website.

Franklin suggests signing up for Part A no matter what because there is no premium. "If you continue to work, you can have access to your employer-provided health insurance; that's a good thing. It will keep your cost lower probably, and you will also avoid the 10% surcharge that you would get if you delay signing up for Part B Medicare."

As long as you are covered by another plan, whether it's through your employer or your spouse's employer, you can then say to Medicare later, "I was covered; I don't have to get hit with that surcharge."

Working seniors also should keep an eye on the high-income premium surcharges for Part B and Part D, which are paid by individuals with $85,000 or more in annual income and joint filers with total annual income of more than $170,000.

Consider strategies that might keep you under the income trigger. One possibility is taking portfolio withdrawals from a Roth IRA, which are not counted in the SSA's definition of taxable income. Or you can alternate withdrawals from taxable accounts so that you don't have to pay the surcharge every year.

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. The views expressed in this article do not necessarily reflect the views of