Social Security: Your Questions Answered

The following is a replay from the 2013 Morningstar Individual Investor Conference.

Jason Stipp: Welcome back to Morningstar's Individual Investor Conference. You're sitting in on the panel Social Security: Your Questions Answered. This has been a very popular topic among our Morningstar readers. In this session we're going to be talking about a couple of strategies, strategies for divorcee, strategies about when to claim your Social Security. This is going to be an increasingly critical issue for retirees as we move forward.

I'm pleased to be joined on this panel by two Social Security gurus, folks who have extreme knowledge of the Social Security system. They're going to be sharing some of those insights with you today. 

To my immediate left is Mark Miller. Mark is a Morningstar columnist. You've probably seen his articles on Morningstar.com. He is the author of The Hard Times Guide to Retirement Security, Practical Strategies for Money, Work and Living. He also writes a syndicated column for Reuters and blogs about retirement planning and saving strategies on RetirementRevised.com.

And joining Mark, who also joined us last year, is Mary Beth Franklin, a contributing editor for InvestmentNews. She is a frequent speaker on retirement issues, and I think she must be some kind of mystical Social Security guru. She knows the answers to all of these situations. So it's great to have you, Mary Beth.

Mary Beth Franklin: Thank you.

Stipp: Prior to joining InvestmentNews, she was a senior editor with Kiplinger's Personal Financemagazine, specializing in retirement planning, tax planning, and Social Security.

So, before we get going. I just want to remind our viewers that we will be taking questions during this session, so to the right of your viewer you can enter a question, send it off, and we'll try to get to as many of those as possible. I should say we got tons of questions before this event. This is an event where there's no shortage of questions. We will be trying to hit some of the questions that come in during the panel. So let's get going without any further delay.

Let's start, first of all, before we get into the tactics, and talk a bit about Social Security, the health of Social Security, some of the policy changes around Social Security. This is an area that seems of perennial concern now. Mark, I'd like to start with you. Can you give us a clear concept about the fiscal health of the Social Security program? We hear these big words like insolvency and big problems that are coming up. What should we know about Social Security's health, the trust fund, how do all these factors fit together?

Mark Miller: So, Social Security is basically designed, Jason, as a pay-as-you-go system, meaning that benefits are funded at base out of the payroll taxes that are coming in at the time as the money is going out. So, that's the payroll tax; we have 6.2% tax that's paid by employees and a same amount is paid by employers. That's the payroll tax.

There is also something called the Social Security Trust Fund, which we're in a very unusual period of time in Social Security's history right now in that we have an enormous trust fund surplus that's been built up, basically as the result of the last time Social Security was reformed, which was 1983. At that time, policymakers looking ahead at the age demographics of the country said we're going to have this enormous age wave of baby boomers. We better do something to build up a cushion to pay out those benefits.

So at that time, the big change that was made was a change of the retirement age gradually from 65 to 67. We're right in the middle of that, but the upshot is that we began accumulating this very, very large trust fund surplus. So where we are at right now is those surplus funds are now starting to get drawn down as baby boomers do in fact start to retire and file for Social Security.

And so, the financial issue the Social Security faces is this: The trustees of Social Security say that that trust fund will be gone in 2033. We'll actually get a new projection on that shortly when the new trustee report comes out; that will be the spring. But 2033 is the year in which we would, absent any other change, be back to a PAYGO system. And with those funds exhausted, we would then be at a point, again absent any other change, where Social Security benefits would have to be cut by about 25%. In other words, the program would only have resources to pay out 75% of promised benefits to everybody using the program.

Franklin: And let me just jump in a second. So, when people say Social Security is going bankrupt, it's not going bankrupt. Even under a worst-case scenario, sometime around 2033 when the trust funds are gone, the payroll taxes from workers in 2033 would still be enough to pay $0.75 out of every $1 of benefits, but no one is going to be satisfied with that. This is the most popular and most successful government program in history, and despite the fact our leaders in Congress have had a difficult time getting much done in the last few years, I really do believe they will rise to the occasion to fix this because the public will demand it.

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Miller: And the very word "bankrupt" has really no meaning in the context of a federal program anyway, so that's a term of sort of art that's out there in the political dialog. But as Mary Beth is saying, the odds of this 2033 outcome happening I think are quite small, and it's interesting, even the Congressional Budget Office projections on the long range of Social Security assume that full benefits would be continued to get paid even if Congress does nothing. The downside of that is that it means that the government would essentially borrow to plug that difference.

So, that's what we have in a nutshell. It's a very manageable set of questions about what you do to fix that problem. Interestingly, a poll that came out this spring asking people, the public, what would you like to see done to solve the problem, overwhelmingly supported the idea of a gradual increase in the payroll tax, number one; and number two, a gradual increase in the amount of wages that are subject to Social Security tax. Right now it's capped at a little under $114,000 of income where that tax is collected. If you, over a 20-year, period make those changes in payroll tax rates and the cap, you would completely eliminate this problem. And the interesting finding, back to your point on the politics, is that about three fourths of Americans across every demographic descriptor you could think of, whether that's age, income, or political affiliation, supported this approach. So, this is probably where, when the dust settles, we will see this go. We will see some reforms done to shore up Social Security.

Franklin: The other important point to make is that when this was created in 1935, it was created as an earned benefit. People pay payroll taxes to support their future benefits. It is not welfare, and that's one of the reasons it is so popular, because people pay into it, they expect to get a benefit, and it's universal; 94% of all Americans pay into this, so it has great political clout.

Miller: The last thing I want to say about this is, well, why is it that we would have this problem of only $0.75 on the $1 come 2033. A lot of people like to say, well, it's because we are all living longer or something along that line. What the Social Security actuaries will tell you is there are really two reasons that there is an adjustment that needs to be made to keep things in balance. One is we've had a declining birth rate. So again, a PAYGO system, fewer workers coming into the system. And the other is the stagnation and weakness we've seen in wages in the country. So there's a broad economic problem we have as a country that's causing weakness in the payroll tax inflow.

Stipp: And, Mary Beth, you also mentioned in our premeeting, before this panel, that this is different than Medicare, too, and this goes back to the idea of an entitlement program versus a paid-in benefit. So when you're talking about Social Security and you're talking about Medicare, even though they often get lumped together, they're really two separate things.

Franklin: They are two separate issues. Social Security, as we mentioned, generally does not add to the deficit. It is paid for with payroll taxes and interest on the earnings; it's self-sufficient. Medicare is heavily subsidized by the government. Retirees pay premiums, but that only covers about 25% of the costs, which means the government is paying about 75% of the cost of Medicare. As we know, health-care inflation is much higher than general inflation, and we have this enormous boom of baby boomers hitting retirement age. So, there is a structural problem there, and things are going to have to be fixed.

Miller: One thing to add to that though is you do have a payroll tax for Medicare, which supports Medicare Part A, the hospitalization program. It doesn't support all of it, but there is a dedicated payroll tax stream just for that part of the program, but as Mary Beth is saying, beyond that, it's really a mix of the payroll tax, general revenue, and premiums.

Stipp: You mentioned that there was pretty strong support for bumping up that payroll tax over time to help cover some of the shortfalls that we might see because of the demographic changes and other things that you mentioned. But other things have been on the table for Social Security, and I'd like to get your take on them. One of them is means testing, so this is something where you would collect Social Security if you didn't have enough money in retirement. So, there would be some kind of an income test before you would collect from it. Do you think this is a possibility that we'll see in the system?

Miller: I actually doubt it. The big reason is you don't really achieve very much with means testing. While it sounds like a very reasonable thing to say, the line you hear about this all the time is Warren Buffett doesn't need Social Security. No debate in that, but the fact is, there aren’t a lot of Warren Buffetts. So the statistics tell you that 90% of benefits from Social Security go to people with $50,000 or less in non-Social Security income, so this is a middle-class program.

Franklin: The other thing is the way the benefits are already structured is that lower-income workers, who haven't had the opportunity to save for their own retirement, get a larger percentage of the benefits. It really is tilted toward lower-income workers, but more importantly everybody who has paid into the system gets something out of it.

Miller: One of the points of confusion about means testing is that the Simpson-Bowles report on deficit commission did include a recommendation that was interpreted to be a means test. It was discussed as means test. And people point to that saying well that would cut half of the Social Security problem out of the picture. But what they didn't really propose true means testing.

Classic means testing is like what we have in Medicaid where you look at person in a current time and [determine whether] they have assets above X or Y to be able to afford something; that's means testing. What Simpson-Bowles proposed really was a change in the formula that measures lifetime earnings and determines your credit. So it's not real means testing; it was looking at your whole lifetime.

So we don't have a real means-testing plan on the table. And administering that I think would be quite complicated because you have to go through this enormous testing; imagine having to submit all these tax returns and so on.

The last point is I think the other reason means testing would be ineffective is it would essentially create a perverse incentive for people to save less, meaning if I know that if I trip a certain number and my benefits get cut, do I have as much of an incentive to keep stocking money away in an IRA? I mean, it's going to come out one side or the other. So there are a lot of reasons that means testing is highly problematic, and I think unlikely to occur.

Stipp: Another thing that could affect benefits is this notion of the inflation indexing. And so there's an inflation adjustment for Social Security payouts, and it's using a certain inflation measure now. There's been talk of changing it to something called the Chained CPI. What is that, and what does it mean bottom line, if it went into effect, for my benefits from Social Security?

Franklin: One of the great values of Social Security is the fact it is inflation-adjusted. Even people who have traditional pensions, most of them don't have an inflation adjustment, which means over the years their pension is worth less. Here Social Security keeps up year after year with your buying power. The way inflation is adjusted now across the board in the government is, it measures a basket of goods, it measures inflation, and it applies this adjustment each year. The Chained CPI basically says well, when steak gets too expensive people just switch to chicken. So, our new inflation adjustment is going to take that into effect.

Opponents of this say, no that's just a benefit cut. And it's particularly difficult for the elderly because their inflation is different. They tend to pay maybe less for food and housing and a lot more for medical expenses. So even under the current system it really doesn't reflect the real sense of inflation and this would just exacerbate it. So, it's talked about a lot again. I think it would be very controversial to impose it.

Miller: And it also is something--of all the different changes that are into discussion--it's the one that it would begin impacting people right away, with that 0.3% difference, which then compounds over the years. So, every year you're starting from that lower base.

Franklin: Because we always say that most people who are 55-plus, 60-plus, probably would not be affected by any proposed changes except something like the inflation adjustment. I think that would be applied across the board.

Miller: The other interesting thing about Chained CPI is most of the proposals on this, this is not just a Social Security thing. It's a change across the entire federal government. So, for example, will it change the way that federal income tax brackets are adjusted for inflation. So, it attracts some opposition from conservatives, too, who dislike it because they see it as ineffectively a stealth tax increase.

Stipp: Mark, you've also done some research around the idea of raising the retirement age. So on the face of it this seems like not unreasonable. People are living longer, so maybe the retirement age should be a little bit higher. But it can actually have, as you found in your work, a pretty substantial impact on your benefits.

Miller: It really is a benefit cut for everybody no matter when you retire. This is one of the things that people don't understand about this question. Because people think, "Well, after all, I will work longer and so on." But the reason that it is a cut is this, that, Social Security is organized around the notion of the full retirement age, which is right now 66, and it's on its way to 67 in 2020.

So, today, if I retire at 65, because of the way that benefits are structured, I would get my full retirement age minus a year's credit. You get more or less against that hoop that you have to jump through of the full retirement age. And likewise, if I retire at 66 today, when the retirement age used to be 65, it used be the 66 was plus one year of credit. So up until, age 70 that sliding movement of the retirement age effectively works as a cut.

To illustrate the changes in 1983 as we mentioned earlier, we gradually moved the retirement age from 65 to 67. The best estimates I've seen on this suggest that, when that change is fully implemented in 2020, people who retire in 2020 will see their lifetime benefits cut by about 15%, as a result just of that move. So, it's an across-the-board benefit cut.

Franklin: But the flip side of that is, yes people are living longer and when Social Security was created in 1935, the 65 as a normal retirement age was fairly arbitrary. That's what [chancellor Otto von] Bismarck had done in Germany for its pension system [in the 19th century], and life expectancy from birth in the United States was only about 62 [in 1935, so the Social Security retirement age] was set as a higher bar.

If you extrapolate the life expectancy we have now, if we did it on the same premises back in 1935, normal retirement age would be about 83 now. So, even if it has gradually increased, it's still a pretty good deal, and you're talking today's 4-year-olds might have to wait until 70 to collect their full benefits.

Stipp: Let's move and talk about some of the nuts and bolts of Social Security. Because this is where we really get into some of the red meat about how people should manage their Social Security benefits, and it can make a big difference. We will start pretty basic. We had a few reader questions asking about eligibility. Mary Beth, can you just lay out the eligibility rules for Social Security and who can collect it?

Franklin: Right. As Mark had mentioned, the current full retirement age is now 66. If you collect at 66, you get 100% of your promised benefits. You can still collect as early as 62, but you will take a permanent haircut. If you start at 62, you will get 25% less. Then there is also this incentive to wait longer, you can wait up until age 70 and for every year you delay between your normal retirement age 66, and age 70, you get an extra 8% a year.

So, that means you if wait until 70, you will have a 132% of your basic benefit. The difference between collecting early at 62 and collecting at 70 is almost double the benefit. And more importantly that bigger base you get will be a bigger base for all the future cost-of-living adjustments. So, for people living longer who can afford to delay their benefits, it's a real substantial chunk of guaranteed retirement income for the rest of their life.

Stipp: And Mark, what kind of work history do you need to have in order to be able to collect Social Security?

Miller: Its 40 quarters of credit.

Franklin: It's basically 10 years.

Miller: 10 years of work basically.

Franklin: And that's part-time work, essentially. You don't even have to have full-time work.

Miller: That 8% that Mary Beth just talked about I think is worth drilling on for just a minute. If you think about delaying for a year, and let's say you are no longer working and you have to fund living expenses out of savings to delay a year--money that you'd have otherwise being using for Social Security--if you thought about that as an investment in an annuity and what kind of return you are getting, that's an 8% return. That beats almost anything you could possibly get.

Franklin: And it's a risk-free 8%.

Miller: And it's going to be an inflation-adjusted 8%.

Franklin: It's extremely valuable.

Miller: So, there has been some really good research on that, comparing different ways to basically buy annuity, and this is one of the very best ways you can do it.

Stipp: So, we have some slides up for readers to help with some of these concepts. So there is a "What's Your Number" slide here? And the slides are also available to viewers in the chat module below. So you can follow along with some of these concepts. We're talking about the full retirement age now at 66, and then there is a range depending on when you were born.

And I just want to talk about some of the core concepts we've already talked about when you can claim and what you can claim? You can obviously start as early as age 62, you can delay it. And Mark, you've written a lot about the benefits of delaying it. We do get a lot of questions about "Well if I invest that money, maybe I can do better."

There is also a concept known as the break-even age. So, what is that, and how does that factor in? Because some people want to collect it earlier because they will start getting paid earlier and pretty conceivably get paid longer is the idea.

Miller: Break-even is looking at this concept of Social Security from a lifetime benefit standpoint and how long do you need to live in order to make back what you would have received had you started at 62, it's that simple. So, I always say that lifetime is kind of the wrong way to look at it. I think you want to look at it…

Franklin: Right, it's income.

Miller: Its income. Maybe nobody banks Social Security, right. I mean I can't think of what that circumstance would be. You use it to meet your living expenses. This is a social insurance program. What is this insuring? It's insuring against the risk of outliving your money. So, whatever you can do to maximize that insurance lifetime, monthly, month-in month-out is the way to look at it. So, that's what break-even though is.

Franklin: But as someone had said to me, you must be present to win. So if you have health issues. I mean this is all based on average life expectancy. If you don't think you're going to make it until 78 or so, go ahead and take it early. But as we'll talk in a few minutes, there are strategies for married couples where it's not just when you take your benefits, but locking in the biggest benefit for the surviving spouse, whichever one that is.

Miller: Great point. I mean, there are a million different reasons why you might want to file early. But that's what break-even is all about.

Stipp: Here is an interesting question from Greg M., and this is a question we got when we were soliciting for reader feedback. If a person is single and will have to take additional IRA funds to make up a difference of not taking at age 62, isn't the advantage of waiting diminished? So I, in other words, will have to start drawing down from my own investments if I don't start at age 62, and it doesn't seem like a good thing because those investments won't work for me as long. I'm starting to maybe tap my capital. How do I make that trade-off of taking money out of my investments to wait [in taking Social Security], or wait and get a higher payout later?

Franklin: Mark is going to take this because I know you want to cite that study.

Miller: And we can put up a link to this later, but there has been some great research looking at that interplay of Social Security and portfolio life. Most of the research suggests that that delaying tactic actually is very positive for the long-term portfolio health, even though it sounds counterintuitive for the reason that the reader suggests. But what happens is that huge increase in benefits that Mary Beth talked about a minute ago takes so much pressure off the need to draw down the portfolio as you move down that path that it's extremely positive. It can extend portfolio life anywhere from three to 10 years, depending on all the variables that would come in there.

Franklin: It can actually help your taxes in retirement later on because keep in mind if you are drawing money from a traditional IRA, you are paying taxes on every dollar you are taking out. But with Social Security, depending on your income, a portion of it is going to be tax-free. So, as you replace more of your income as you get older with Social Security benefits that are not fully taxable and reducing the amount of IRA withdrawals, which are taxable, you could actually end up paying less in taxes.

Miller: And it gives you maybe more flexibility in managing that mix.

Franklin: Exactly.

Stipp: Lots and lots of questions about couples strategies, so we have some couples planning basic key concepts, and, Mary Beth, you had supplied this information for us, so thank you for that. Again, you can download these slides in the chat module that's below the viewer. But let's talk about some of the key concepts behind couples planning before we dig into some scenarios. What's the basic framework for how couples' Social Security benefits work?

Franklin: The basic concept is, as a worker who has at least the minimum amount of 10 years of work, they're going to qualify for Social Security benefits on their own work record. Their spouse, let's say, this spouse never worked and I'm going to say it's the wife, but it’s gender neutral, the spouse qualifies for benefits equal to 50% of what the worker gets. That's in addition to the worker's 100%.

Now a lot of it is age-based. I’d like to call 66, the current retirement age, full retirement age as the magic age for three reasons. If you wait until 66, you get your full retirement benefit. If you wait until 66 and you continue to work, you get your full benefits without any reduction from the earnings cap, which we can talk about in a minute. And most importantly, if you wait until the magic age of 66, you can exercise some of these strategies, which for married couples, and that can even include widows and divorced spouses in some cases, you can really maximize your benefits. So maybe you want to give us the question and we will give an example of how it works.

Stipp: So there are several long questions. So the question from reader, Steph. "My husband is retired. When I turn 62 in three years, can I collect his Social Security and wait to collect on mine until at least my full retirement age?"

Franklin: Greatquestion, and the short answer is no. Yes, she can collect at age 62. She will get that permanent 25% haircut on her own. But anytime you collect benefits before the magic age of 66, you can't separate it. You have to take the highest benefit to which you are entitled, whether it's your own benefit on your own work record, or as a spouse. If she waited until 66, she can exercise this wonderful strategy called "restricting a claim to spousal benefits only." She could say, my husband is collecting his benefit, I'm 66, tell Social Security I just want my spousal benefit, which is half of his. My own benefit is going to keep growing by 8% a year, and at 70 I'm going to switch to my own. And it's going to be worth a 132% of what it would have been at 66. This can be an enormous strategy for couples trying to maximize the retirement income.

Stipp: Another question, another scenario: "I have just turned 66," so that’s that magic age. "I am working full-time at a job with a six-figure salary, which I plan to continue," so making a good salary. "I'd like to start receiving my full Social Security benefit right now, but I hesitate because I wonder about my spousal benefit from my wife, who is retired, versus my benefit. Is it better to take the spousal benefit first and wait until 70?" So, there are, obviously, some variables here.

Franklin: It's exactly the scenario we just described, because he is 66, magic age. He's at full retirement. He can keep working. He won’t lose money to the earnings cap, and he can say to Social Security, "Restrict my claim to spousal benefits only, give me half of what she's getting, and mine is going to keep growing at 8% a year."

Miller: One other thing about that situation that’s interesting is, he's in a situation where he could trigger problems with Medicare because if he’s got a high income plus Social Security, he is going to be above the $85,000 for individuals, and I’m forgetting the number.

Franklin: $170,000.

Miller: $170,000 [for couples filing a joint tax return]. It's possible you could trip the number that pushes you into the high-income Medicare premium surcharges, which are very large. So, if you have high ordinary income from work, you really want to watch your strategies for additional income coming in for Social Security for these other reasons, outside of just maximizing Social Security.

Franklin: This is not your grandfather's retirement. It's gotten really complicated.

Stipp: On that point, so there are a lot of different variables to keep in mind here. Are there any tools that you guys like to try to figure this out? Because everyone’s situation is different; we are taking some questions from readers now, and I would advise them as well to really think through these issues. We don't have all of their information, but there are a lot of variables, lot of moving parts here. Where can people go to get a better sense of what's a good plan essentially?

Franklin: Do you want to start first, Mark. I mean, there is a lot of great stuff out there.

Miller: Yeah. We probably agree on some of them. There are a variety of tools online that are both free and some that have some small fees attached. In the free category, you can go on the Social Security website to just get an estimate of your own benefit, and also a play with different retirement ages. It's fairly basic. The AARP website also has a pretty good free tool that lets you play with different scenarios for your filing.

Franklin: It's a good educational tool.

Miller: It's a good educational tool. AARP also launched recently that's I think terrific is an online searchable database of most frequently asked questions. It's sort of the technology version of Mary Beth. She knows all this in her head. They've got it in the database. Slightly more sophisticated, but also involving a fee, one that I think is terrific and I think [Mary Beth likes], too, is called socialsecuritysolutions.com.

Franklin: Absolutely, yeah.

Miller: Launched by a couple of people who are actuarial experts and academics in this area. For a reasonable fee, it ranges depending on what level you take, from $80 to a couple of hundred dollars. You put in a very small amount of information, the work required on the front end is small, one of the reasons I like it. You put in your and your spouse's birth dates, Social Security numbers, and a couple of other things.

Franklin: And your estimated benefits.

Miller: And your estimated benefit, you go get that from the Social Security site. It then spits back a 20-page PDF document outlining different strategies you might consider for maximizing benefits. I think that's pretty slick, and for a couple hundred dollars, boy, is that a possible big return on your investment.

Franklin: I think it's one of the best things out there for consumers. There's other software out there for financial advisors. But I really think this is the best for consumers, and they actually have a Step B section to that software called retireeincome.com. It's affiliated with Social Security Solutions, and for those people who want to look at their whole retirement-income picture, including the tax efficiency of drawing down from different accounts and how their Social Security fits into it, I think it's well worth the money involved. It’s not a big expense, and you are talking perhaps a difference of $100,000 over the joint lifetime of a married couple.

Miller: And what's so great about that, too, is just that it doesn't require a ton of work on the front end. Some of the tools that are out there, you can spend a whole weekend just inputting data, and this is very, very slick and simple.

Franklin: One other point mentioning the Social Security site itself, a lot of people do not realize that the Social Security benefit is no longer in the mail. Because of budget cuts, Social Security is no longer mailing these out.

Miller: You mean the statement, the annual statement?

Franklin: The statement, I'm sorry. The statement, correct. So if you want your information, which I encourage everyone to get, they need to go to ssa.gov and set up their own, it's called My Account, and it's actually your personalized statement just like the old paper one used to be, but online.

Stipp: Mark, I heard Mary Beth mention a $100,000 figure. These are important decisions, and you mention that there is big implications for getting this right. So these are some great tools that you've mentioned, but we are talking about a lot of money here to make sure that you make this a good decision.

Miller: Yes, and it's surprising. This is a big deal for middle-class households. It's a big deal for what you might call mass affluent households, and even for wealthier households. I did a column recently on this subject. We took this question of, all right, what if 2033 rolls around and the unlikely happens, that benefits were cut 25%, just because you hear this discussed so much in the press. It's like, well, everybody should be discounting their benefits because we know this problem is coming.

So, working with a financial planner we actually created scenarios for different sort of levels of wealth with some hypothetical households, and it was really interesting to see the implication of a cut in benefits even on fairly well-off households because of these issues of longevity, portfolio exhaustion that can incur in the far-out years, particularly with woman living longer than men, there is this issue of running out of money, and that's the thing that Social Security is so good at. So, one way of looking at your question is a benefit cut, the other is making the best decision plus/minus 10%, lifetime 15% of your benefit can be a very big deal, and I was surprised to see how far up the affluence ladder this impact actually goes.

Franklin: Following on that point. Mark mentioned the importance of survivor benefits. This is what a lot of people don't understand that when a husband and wife are making their decision of when they are going to claim their benefits, their main goal for most people should be to get the biggest benefit possible for the surviving spouse, and the way Social Security benefits work, we talked about a spousal benefit is 50% of the worker's benefit; a survivor benefit is a 100% of the worker's benefit including those 8%-a-year delayed retirement credits. So, for that higher-earning husband who delays taking his benefits until 70, he is not just getting the biggest bang for his buck, but if he dies first and sorry guys that's actuarially the way it is going to work, she will have this bigger benefit for the rest of her life, the smaller benefit will disappear at that point, but the household will maintain the biggest benefit.

Miller: I think that point ties back to what we were talking about earlier on break-even, this notion of the break-even point, because when you look at married couples there is a pretty good chance that one member of the household will far exceed…

Franklin: Make it until 92, yeah.

Miller: …the break-even point. So, these strategies become so important. It's timely to be talking about married couples right now too because the Supreme Court [is hearing] the issue of the Defense of Marriage Act, and I think we even got a few questions about civil union and so on. This is an issue I've written some about, whatever gets decided on the Defense of Marriage Act will have a big implication for Social Security benefits for same-sex couples. Civil union is not a relevant concept to Social Security because of DOMA. DOMA essentially, as we know, defines a marriage between a man and a woman. So, Social Security and any other federal program that has its hands tied can only look at a married couple under that definition.

If that changes, then Social Security will change, and it will then recognize any married couple. So if you live in a state with same-sex marriage, you will, to Social Security, look the same as a traditional hetero marriage. So, that's going to be a big deal, and a lot of people are watching it closely. And because of all things we talked about, the importance of these spousal strategies, the implications for retirement security for same-sex couples is huge. It also has applications for Medicare, 401(k), IRA, it goes way down the path.

Stipp: Another question that involves the spousal benefits and the survivor benefits we got from the reader, what if one spouse has not completed 40 quarters of work? How does that work as far as spousal benefit or the survivor benefit?

Franklin: Well, remember, as long as you are married to someone who qualifies for Social Security, you qualify for spousal benefits. This was designed for Ozzie and Harriet back in the 1930s when most women did not work. So as long as one member has Social Security benefits then the spouse can get it.

The other thing I'd like to mention, when I go around the country talking about this, the question I get the most is from divorced spouses. So many people do not realize that if they were married to the same-spouse for at least 10 years and are currently not married, they too are entitled to spousal benefits just as if they were married. And what's really important is that ex-spouse doesn't even have to file for benefits. They just have to be old enough to file for benefits. So, they can't say "I'm never going to retire; I'm never get die." As long as that ex-spouse is 62 and you are at least 62 and you are married for 10 years you can quality for spousal benefits, but more importantly, you could use one of these strategies that wait until 66. And [then you can say] to Social Security "I want to restrict my benefits to spousal benefits only," collect on the ex, and let your own benefits grow 8% a year up to age 70.

Stipp: Since you brought up the issue of divorce, we did get a reader question. What about in the case of re-marriage, how do benefits work there?

Franklin: If you are divorced, you must be unmarried to collect on an ex-spouse, but if you are a survivor, you're a widow or a widower, and you wait until after age 60 to remarry, you can continue your survivor benefits. Even if you were divorced and the ex died and you waited until after 60 to remarry, you can collect. Believe it or not, I get calls from people, "I've been married three times," as long as they each lasted at least 10 years, you get to pick the benefit of the highest benefit. It's like tic-tac-toe.

Stipp: So let's move on to what you call Magic Strategies, Mary Beth. We have some information here for readers that you provided for us. And these are strategies where couples can essentially maximize their payments. Some folks have heard a little bit, we got a few questions about them, but let's walk through the basics of the Magic Strategies, the first is called file and suspend. How does that work? When would you use it?

Franklin: And again, this is the idea. You must wait until 66, the current normal retirement age to do this. But let's say you have an Ozzie and Harriet situation when the man has worked his whole life and the wife has little or no earnings on record. He wants to keep working until 70 because he knows he wants to maximize that survivor benefit; she, frankly, would like some money now.

If he waits until 66, he can say to Social Security, "I want to file and suspend." For that purpose, that triggers her spousal benefits, so she can collect, as long as she's at least 62; he does not collect his. His continues to grow 8% a year up to age 70. This is the best of both worlds. It allows a couple where there's a major earner and maybe one with little or no earnings to get some income now, collecting spousal benefits and then delaying the biggest benefit until later, and this works not just with spouses, but with minor children. We have so many older men who have second marriages, pushing the baby carriage with their AARP card. What a lot of people don't realize is if a parent is collecting Social Security retirement benefits and there are minor dependent children in the household, the children each get benefits up to 50% of the amount of the retirement benefit subject to a family maximum. So, you have two kids that are 12 and 14, dad gets retirement, they do too.

Stipp: Let's take a scenario here and you can talk through and see how this applies potentially. So, Richard asked, "My wife and I are interested in maximizing our Social Security. I don't plan to start drawing Social Security until I get the maximum amount. We are both in good health. We have enough saved so that we won't need to begin withdrawing from our accounts until later. I've heard the younger spouse applying for spousal benefits when they turn 62 then changing to their own benefits when they turn 70."

Franklin: That doesn't quite work that way. They've got it a little confused. Yes, she could collect as early as 62 with that permanent reduction, she'd get 75% of her benefits, but any time you collect benefits before your normal retirement age, you lose the opportunity for these other strategies like file and suspend or whatever. So, she couldn't just turn 66 and say "I want my own benefits now." She's given up that opportunity, but again, when you look at a married couple as an economic unit, in many cases it does make sense for one to claim early even though it's reduced and for the other to claim later to get the maximum benefit, because here's something else people don't understand. Social security retirement benefits and survivor benefits are two separate pots of money.

Even though she takes Social Security benefits at 62 and the retirement benefits are permanently reduced, if he dies she steps up to a survivor benefit 100% of what he got, and as long as she is at least normal retirement age when she collects a survivor benefit, there is no reduction. So, she really has her cake and eat it too, get the reduced benefit now, step up to bigger retirement benefits when he claims and then step up to unreduced survivor benefits.

Stipp: So, in the case where someone might be taking at 62, that would usually be the lower-income earner, because the higher-income earner you are wanting to wait until at least that normal retirement age?

Franklin: Right. And then here is what I'd like to do for power couples, they both have substantial earnings on their own record. They can do a combination. Now this assumes they are both roughly the same age. At 66, the higher earner can say to Social Security, "I want to file and to suspend." That triggers benefits for the spouse, who is also 66 and says, "I want to restrict my claim to spousal benefits only."

What happens is, one gets zero for right now, one gets a spousal benefit worth 50%, both of their benefits continue to grow 8% a year, and at age 70 they both get their maximum benefits. To give you an idea how much money we are talking about, if both of their normal retirement age benefits were about $2,000 a month, by the time they got their maximum benefits, that works out to about $72,000 a year combined. And that’s cost of living adjusted for the rest of their lives.

Stipp: A question from Andrea, she asked about civil unions, but she also said what criteria should one consider when deciding if marriage is more advantageous for Social Security versus if both people remain single. So, it sounds like married couples do have access to other strategies.

Franklin: Exactly.

Stipp: A good idea if you are so inclined anyway to go ahead and get married if you're not already, versus some sort of separate benefits?

Franklin: I'm sure Social Security is reason enough to get married, but I would like to see marriage vows change to say and in the event death does not do us apart make it at least a decade because people who are married nine years and get divorced can't use these divorce strategies. So, I would like every divorce attorney in the country to be aware that marriages need to last 10 years in order for an ex-spouse to get benefits.

Miller: Yeah, setting aside the relationship side of things, marriage is very beneficial in Social Security. The rules are designed very much around helping married couples.

Stipp: Let's just review, you already talked a bit about the divorce rules, but we have a slide for folks, you mentioned collect on your ex. So, let's just review what the rules are again so folks are clear. If you are divorced, when can you collect, when can't you collect, and what do you need to really keep in mind about that?

Franklin: The first rule is you must have been married to the same spouse for at least 10 years. Now, you could have been married three years, gotten divorced, remarried the same person for seven years, that works. You're married at least 10 years to the same spouse; you're divorced and currently unmarried--that's the other key. Then you can claim spousal benefits equal to half of the worker's full retirement age benefit as early as age 62, but anytime you collect before age 66 and you're still working, you're going to lose some benefits to the earnings cap, and you can't get fancy with your strategies.

But since so many divorced women have to keep working, if they wait until 66, they can a file restricted claim for spousal benefits only, collect half of their ex's benefit, and he doesn't even have to know about it. It doesn't take money away from him. He could be remarried to another wife. It doesn't affect her. You still get this benefit. And then wait until age 70 and collect your own benefit which at that point is going to be worth 132% a year. And again remember spousal benefits are 50%, survivor benefits are 100%. If your ex dies you may be entitled to get a survivor benefit, even if he is remarried worth 100% of what he was entitled to.

Stipp: So, these are very important things to keep in mind for folks who had been married before. I think you covered some of these survivor benefit key topics that you had listed. We had a few questions on survivor benefits from some of our readers that we got when they were registering.

So, Benny asks, "My wife's family lives a long time, often into their 90s. My wife has been a housewife almost all her wife and she has almost no Social Security. I am two years younger than my wife. How can I make sure we maximize our Social Security for both before and after I am gone?" So, a lot of topics we have already talked about could come into play here, but what would you suggest in a scenario like this?

Franklin: Right. Now, it does get harder when the lower-earning spouse, often the wife, is older because she often has to wait for him to file to trigger her benefits. If she had any work history of her own, she probably wants to go ahead and take it at 62 even though it's reduced because she has got to step up to a survivor benefit later. If she has no benefits on her own, she can't claim. She has nothing to claim on. So, he might want to wait until he is 66, she would be 68 at that point, he would file and suspend for the purpose of triggering her benefits. He would delay collecting his own until age 70 when they are worth 132%. That way they have this big chunk of money as a couple and whoever dies first whether it's a husband or a wife, the largest benefit is going to survive, the smaller benefit will disappear. So, it's a great strategy for couples.

Miller: Especially, when you have expectation of a great deal of longevity.

Stipp: Another question, we got a couple of questions like this as folks were registering for the event. "My question is one of timing and benefits of taking Social Security for both spouses. I am age 66 and my wife is 55. I plan to begin taking Social Security at age 70. Her retirement benefit would be smaller than mine at any of her ages 62, 66 or 70. Is there an effect to my spouse on when she claims her Social Security benefit once I have passed? I have to assume that I may or may not have passed by her ideal age to take Social Security."

Franklin: Good point that you raised because we keep talking about the early retirement benefit at age 62, but it's different for survivors. Widows and widowers can collect as early as age 60. So perhaps in this scenario, he has died, she can get survivor benefits as early as age 60. Now, they will be reduced compared with what they would have been at her normal retirement age, and again, we mentioned earlier that retirement and survivor benefits are two different pots of money. So depending on what her own benefit was, she could take survivor benefits at age 60 until age 66 when her own retirement benefits could kick in at the full benefits. There's lots of ways they can play around with that.

Miller: Could she then go back to survivor benefits at a later point or once you've done that, you're done?

Franklin: Probably you would only do which would be higher.

Miller: Which would be higher, yeah.

Franklin: And the other thing to keep in mind is, if you collect benefits before 66, and you're still working, you're going to lose money to the Earnings Test, and maybe that's something we should talk about now. We keep referring to the Earnings Test without explaining it. [Mark,] do you want to go into it?

Miller: Go ahead.

Franklin: The Earnings Test says if you collect benefits before your normal retirement age and continue to work--this is money from a job, not from investments--in 2013 there's an earnings cap of $15,130 a year, I think. If you earn more than that, basically you lose $1 in benefits for every $2 you earn over the limit. Effectively that means if you earn more than $45,000 a year, all your benefits go away. They're not gone forever. They're actually deferred. What happens is, "I took benefits at 62. I kept working, I earned, and I've to give money back." When I get to my normal retirement age, Social Security looks back at my record and said, "Well, you claimed at 62, but you gave back two years' worth." So, it's really as if you claimed at 64, so you get a smaller haircut in benefits than you would have otherwise.

Stipp: We have about five minutes left. We got a lot of other questions I'd like to try to get to. Hopefully they will be a little bit easier and not quite as complicated as all the scenarios, but we have a few questions on Social Security and Social Security disability, and I think that there is some confusion here about these benefits. So, one is, "I am 62 and receive Social Security disability payments. When Social Security retirement benefit payments begin at age 66 will I receive the same amount as my Social Security disability payment?"

Franklin: Yes. Basically, it's an accounting change. You get the same check; it's just now called "retirement" rather than "disability."

Stipp: I think we touched on some of this before, when we were speaking of taxation issues, but when again are Social Security benefits taxable? What tax do you pay on them, and what should folks keep in mind about tax liabilities with Social Security benefit?

Franklin: [Mark,] would you like to go into this?

Miller: I'm struggling remembering the number now; you probably have it at your fingertips.

Franklin: Anyone who is single, whose provisional income, which I will explain in a second, is above $25,000, some of their Social Security benefits will be taxed, and for married couples, it's above $34,000 joint income. But it's not income the way you normally think of it for taxes. It's all of your taxable income plus all of your tax-exempt income like if you invest in municipal bonds, plus half of your Social Security benefits. And when you add that together, if you're single and that adds up to more than $25,000, some of your benefits are going to be taxed. If you're married, if it's over $34,000, it would be taxed. There are two levels. Up to half of your benefits could be taxed and then when you hit the second tier, 85% could be taxed. But if you look at it the other way, you're guaranteed that at least 15% of your Social Security benefits will not be taxed under any circumstances compared with taking money out of a traditional IRA where everything is taxed.

Miller: This gets more interesting as more people work longer. So, this is going to become a more important issue, the same as Medicare, some of these things we were talking about earlier with these high-income surcharges. So, work and retirement is going to get to be a much more interesting and complex planning topic.

Franklin: And the other thing, this was a result of the big changes to Social Security in 1983 when they taxed benefits for the first time, but those levels have never been indexed for inflation. So, every year as people's incomes rise more and more people are paying taxes on their Social Security benefits.

Miller: Another point here is that some states levy taxes on Social Security benefits and some do not.

Franklin: Right. I think about 36 states do not tax Social Security benefits at this point. So, when you're looking at where to retire, it's one of the things to think about.

Miller: [Mary Beth,] you'd know this. States that do [tax], do they use the same formula that you described the federal level?

Franklin: It's sort of all over the lot. Some use the federal income tax as the base and some don't.

Miller: OK.

Stipp: So, when you were laying that out, you included investment income as part of that calculation? We had a question about someone who had inherited a 401(k) and has to take payments from that 401(k).

Franklin: That's taxable income.

Stipp: So, that will considered as in part of the calculation?

Franklin: Yes.

Miller: That's ordinary income.

Stipp: A question, an interesting one, "Does the spouse need to have a Social Security number to get spousal benefits?" The spouse is on a dependent visa, the question says. Do we know about how works?

Franklin: That's a really good question. I don't know the answer to be honest, and rather than guess wrong, I'll just say I don't know.

Miller: We'll get back to you.

Stipp: And lastly, I think we have just about a minute left. Mary Beth, you recently wrote about something called lump sum; the lump sum option in Social Security, how does that work?

Franklin: Basically, once you've reached your normal retirement age of 66 and you choose to delay at some point beyond that, when you start your benefits, you can request up to six months of retroactive benefits as a lump sum. But you can't double count. Let's say, if I were planning to start my benefits at 66 in six months, and I say give me six months of a lump sum, they're going to calculate my future benefits as if I claimed at age 66. So you can't do both. But some people like to look at this as a bonus: "This is how I afford that trip to celebrate retirement."

Miller: Have you looked at how that decision would impact your future trajectory of income?

Franklin: Certainly, it's going to reduce your base amount compared with not taking it, which of course will reduce the amount you get in cost-of-living adjustments going forward. So, it's probably a feel-good upfront hit, but if you're going to delay anyway, you might as well just get it for the rest of your life.

Stiff: Well, unfortunately, we're going to have to wrap it up and call it a day there. I want to thank my panelists for, as last year, bringing some really great insights and some really, really useful information on this very important topic. Social Security income is going to be a hot topic for retirees for a long time to come.

So, Mary Beth Franklin from InvestmentNews; thanks for joining me. Mark Miller, Morningstar columnist, author, and retirement expert, thanks for being here.

Miller: Thank you, Jason.

Franklin: Thanks a lot.