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 a difference of thousands of dollars in lifetime benefits or costs.
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 monthly benefits increase 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 or face other emergency spending needs may 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 enough to beat the "break-even point" when total benefits received exceed the income forgone while waiting.
Social Security's filing rules are built around the program's full retirement age, or FRA (currently age 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 people will do better making a choice that boosts their monthly payout--especially married couples. Studies show that higher monthly benefits are helpful--even for households that have done a good job saving for retirement--in the out years in cases where one or more beneficiaries far outlive mortality averages.
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, 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.
Two online tools that I like for running what-if projections are at Financial Engines (free) and Social Security Solutions. Both are especially good at offering up strategies for couples. For individuals, the Social Security Administration Retirement Estimator also is helpful.
Moreover, if you have income from wages earned in your 60s, it makes little sense to file early for Social Security. Earlier filers in 2016 will see some of their benefits held back if they have income above a certain level--$15,720 in 2016, in most cases. (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 above 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 valuable 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.
Until recently, couples also could execute complex claiming maneuvers using "file-and-suspend" and "restricted claims," which allowed a household to delay some benefits while getting spousal payments flowing. Those strategies are being phased out under federal legislation passed in November; some couples that fall inside a birth-date window may still be able to execute file-and-suspend strategies.
All couples will still be able to benefit by considering a range of options. Should one or the other spouse start benefits early, should both delay, or should both file early? Most often, couples will benefit if the higher-benefit spouse delays filing to earn delayed credits. Divorced people also can qualify for a spousal benefit based on the ex-spouse's wage history if they meet certain criteria.
For more details on how Social Security benefit amounts are determined, see my Morningstar interview with Stephen C. Goss, chief actuary of the Social Security Administration.
Medicare 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 you turn 65 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 payer 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 claimer 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.
Consider 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, which will keep your cost lower, and you will avoid any risk of the 10% surcharge for a late sign-up. (Note, however, that if you are enrolled in a high-deductible health plan and have a health-savings account (HSA), you can no longer contribute to your HSA if you are enrolled in Part A or Part B.)
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. You can find a summary of the current surcharges here.
Consider tax-diversification strategies ahead of retirement that might keep you under the income trigger, such as contributing to a Roth IRA or converting assets from a traditional IRA to a Roth. Although most people assume they will be in a lower tax bracket after 70, leaving everything in a tax-deferred IRA or 401(k) actually can push you into a higher tax bracket in retirement because of required minimum distributions (RMDs), which begin at age 70 1/2. RMDs are not required with a Roth. At the same time, reducing the value of your tax-deferred holdings will reduce your RMDs from those accounts.
For Medicare premium purposes, portfolio withdrawals from a Roth IRA are not counted in the definition of taxable income.
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 Morningstar.com.