Social Security: 4 Filing Pitfalls

Social Security claiming strategies can be devilishly complicated. Morningstar director of personal finance Christine Benz recently interviewed Phil Moeller about some of the frequent mistakes that investors make in Social Security claiming. Moeller is the co-author of a new book about Social Security called Get What's Yours.

Christine Benz: You hear from individuals grappling with questions about Social Security claiming. Let's cycle through some of the key pitfalls that you have observed. One is relying on a break-even analysis to guide decision-making--in other words, thinking about claiming early and investing Social Security proceeds. You say that individuals should instead wait to claim and think about Social Security as an insurance policy.

Phil Moeller: One of the strongest discussions we have with individuals is this idea of a break-even analysis. It's very beguiling to think that if you take benefits at age 62 and invest them for eight years at a reasonable rate of return, you'll end up with a very nice pile of money--and it would take you a long time to earn that money back in the form of the higher Social Security payout that you would receive if you waited until age 70 to take benefits. When people conduct these analyses, they often wonder, "Why should I wait to take benefits?"

But my feeling is that Social Security is the absolute-best longevity insurance we have. The payments are guaranteed by the government. They are inflation-protected. And the tax rate on Social Security is never more than 85% of your federal tax returns in terms of the number of dollars that are taxed. Social Security dollars are valuable dollars, and the ones you should hold on to and maximize.

Because of gains in longevity, the average life expectancy of someone who is now age 65 is going to be in the mid-80s--and later 80s for a woman. By the time people in their 50s are getting ready to retire, the average life expectancy could well be in the 90s. If you are part of a couple, the odds are very high that one of the two of you is going to live well into your 90s. As we say in the book--only partially tongue-in-cheek--your greatest fear in life isn't dying; your greatest fear is living to a really old age and outliving your assets. Viewing Social Security as longevity insurance is a good way of taking the best advantage of this great asset.

• Read more: When Should You Take Social Security?

Benz: And delaying benefit claiming gives you the full merit of that longevity insurance.

Moeller: Absolutely. By waiting until age 70 to claim rather than claiming early at age 62, you receive a 76% increase in the monthly benefits that you receive for the rest your life. For most people, delaying can almost guarantee that you won't outlive your money.

Benz: You make an important point about life expectancy in your book. A 60-year-old who looks at life-expectancy tables sees that the average life expectancy is 85. But 50% of today's 60-year-olds will live to be older than 85.

Moeller: Much older. If you're taking good care of yourself physically and you're paying attention to what you eat, the odds of you living longer are somewhat greater, and the studies bear that out.

Benz: Another mistake to avoid is something known as "deeming." What is deeming, and how does it come into play?

Moeller: If you claim a benefit before full retirement age, which is 66 for people nearing retirement today, you will also be "deemed" to be taking any other eligible benefits under Social Security rules.

For example, if you're eligible to take a spousal benefit before your full retirement age, you would be taking both the spousal and your own retirement benefit simultaneously, and Social Security will not pay you the full amount of each of those two benefits. Social Security will pay you an amount roughly equal to the greater of the two. In addition, by claiming your retirement benefit before full retirement age, you reduce the amount of money you get from those benefits for the rest your life.

Deeming is a surprise to a lot of people. We've talked to many readers who never even realized that this had happened to them. They thought they were getting only the benefit they asked for and they learned later that they were actually getting a deemed benefit that was the greater of the two. And in some cases, when people said, "I want to file for a spousal benefit and then later I'll file for my own retirement," they came back later and they realized they'd already filed for their own retirement benefits and didn't even know it.

That's why full retirement age is a very important measure. If you do something before that age and are deemed to have filed for another benefit, it can be a serious gotcha.

• Read more: 3 Ways to Maximize Social Security Benefits

Benz: Another key pitfall you talk about in the book is failing to coordinate your claiming strategy with that of your spouse. Let's talk about why that is so important for couples who are attempting to figure out the optimal time to file.

Moeller: Many people don't even know that spousal benefits exist. Studies have indicated that upwards of $10 billion in spousal benefits are left unclaimed every year. In our view, that's money that you should get; it's part of Get What's Yours. Trying to alert people to the availability of spousal benefits is a big, big need.

The second need is making sure you time those benefits properly so that you can take ultimate advantage of them. Granted, timing can be complicated. Spouses can be different ages, or they can have different income levels that will affect the decision over which spouse should take a spousal benefit while the other one defers his or her retirement benefit.

In some cases, you can have the same income levels, but if the spouses are different ages, the indicated action can be different depending on when their claiming windows are the most ideal--which goes back to this idea of waiting until full retirement age to claim a benefit.

In addition, when you take a reduced benefit early, it adversely affects the survivor benefit that your spouse will get if you pass away before he or she does. In the real world, this means that women are disadvantaged because they are often younger than their husbands, they live longer than their husbands, and they make less money. In this context, Social Security is a significant women's issue. I would urge men to think about how they can optimize the retirement benefits of the people they love the most and the people they may leave behind--their wife and their children. One way is to defer taking your benefit to make sure their benefits after you pass away are the greatest they can be.

• Read more: One Social Security Strategy That Can Pay Off Big

Benz: Another pitfall you discuss in the book is that people don't necessarily take advantage of do-overs. If it turns out that their initial claiming strategy was misguided, there is an escape hatch.

Moeller: You have a year in which to say, "I want to change my mind." If you do that, you have to pay back all the money you've received. And if you have Medicare premiums taken out of your benefit payment, you have to repay those premiums as well. You basically have one year to wipe the slate clean, as if you never filed at all. If you've made a mistake and you say, "Wait a minute--I didn't fully realize the benefits of waiting longer, and I want to go back," you have a year to do that. It used to be you had an unlimited window, and several years ago they reduced it to a year.

Benz: One particular situation where that might have applicability would be a same-sex couple, because same-sex marriage laws are changing so quickly.

Moeller: When we started researching the book, the number of states that had approved same-sex marriages was in the single digits. By the time we finished the book, it was above 30. It has been a tremendous change. If you are in a same-sex relationship, perhaps you took Social Security before marriage was legalized in your state. If that happened within a year of your claiming decision, you should go back and look at whether or not you should rescind that claiming decision so that you can take full advantage of all of these ranges of other benefits we've talked about. You can get spousal benefits; you can get child benefits. For anyone who is in that situation, think about whether or not you might be entitled to go back and basically do a do-over.

• Read more: Want Help With The Big Social Security Decision?