Summary/TLDR
Mistakes with social security are frequent, costly, and often permanent. The most common pitfalls include claiming benefits too early or too late, failing to coordinate benefits with your spouse, not understanding how social security is taxed, relying too heavily on benefits, and not planning for the unexpected passing of your spouse. Getting ahead of the curve and avoiding any one of these missteps can go an exceptionally long way in improving your retirement plan.
Introduction
For many, social security can make up a considerable amount of retirement income. However, decisions with social security are often permanent and irreversible, making any mistakes extremely costly.” “Maximizing” your benefit is therefore a crucial component of crafting a successful retirement plan. In this piece, we’ll discuss six common yet costly mistakes that you’ll want to avoid.
1. Starting Too Early
Claiming Social Security benefits prematurely can result in a substantial lifetime reduction. For every month you claim benefits before your full retirement age (FRA), your lifetime monthly benefit is reduced by about 0.5%. If your FRA is 67, this means you are looking at a lifetime reduction of up to 30% in benefits by claiming at age 62! To put this into perspective, a monthly benefit of $3,500 at age 67, it will only be $2,450 if claimed at 62.
Claiming early doesn’t only impact you. When you pass away, if your benefit surpasses your spouse’s, then they will inherit your benefit. Consequently, if you’ve accessed your benefits early, your spouse will inherit this permanently reduced amount. While certain circumstances might warrant beginning Social Security benefits early, it is advisable to wait until FRA or later for a majority.
2. Starting Too Late
Ironically, just as starting too early can be problematic, so can delaying for too long, especially for those planning on claiming benefits on their spouse’s record. If you plan on claiming spousal benefits, then your benefit will be 50% of your spouse’s FRA benefit if claimed at age 67. As discussed above, it will be less if you claim earlier. However, it will not be more if you wait to claim beyond your full retirement age.
The same is true for survivor’s benefits: claiming early results in a permanent benefit reduction but delaying beyond FRA will not accrue any additional benefits.
3. Not Coordinating Benefits With Your Spouse
Claiming your benefit in isolation from your spouses can be a very costly mistake.
A common strategy is for the spouse with the lower benefit to file early while the spouse with the higher benefit waits until they are 70. This ensures that if one spouse passes away, the surviving spouse will receive the highest possible benefit. Moreover, it provides a maximized benefit for as long as both partners are alive.
On the other hand, if one spouse hasn’t worked long enough to accrue significant benefits, it may not be beneficial for the higher-earning spouse to delay benefits until 70.
Given that Social Security decisions are generally irrevocable, it’s paramount to make this decision with professional guidance.
4. Failing To Plan For Taxes On Social Security Benefits
Many people don’t know that most of their social security benefits could be taxable without careful planning. The percentage of benefits subject to tax is determined by your “provisional income”. Specifically, if your provisional income is between $32,000-$44,000 as a married couple, up to 50% of your benefits might be taxable. At provisional income levels beyond this, up to 85% of your benefit can be taxable. The tax treatment of social security is often referred to as “the social security tax torpedo” because each additional dollar of provisional income is not only taxed at your marginal income rate, but also pulls more of your social security benefit into being taxed!
To illustrate, let’s look at an example. In 2023, if you and your spouse drew $50,000 in distributions from your Traditional IRA and received a combined social security benefit of $34,000, then federal income taxes for the year would be $4,940 with 75% of your social security being taxable. If you instead took only $35,500 from your Traditional IRAs and $11,360 from Roth IRAs, your tax bill would shrink to $1,800 because only 39% of your social security would be taxable.
This is another reason that delaying benefits can be advantageous for most. Continuing our example above, if benefits were delayed until age 70, you would only need $27,500 from your Traditional IRA and $10,070 from your Roth to receive the same net income, but your tax bill for the year would only be $670!
5. Relying Too Heavily On Social Security Benefits
Social Security is designed to give a larger payout to lower income workers, and a smaller payout to higher income workers. Lower income workers can find that social security will cover up to 90% of their wages, while higher income workers will only have about 30% of their wages covered by social security.
Not many people would welcome such a severe adjustment to their budget and, consequently, living standards. For most, social security is not enough to maintain their current standards of living, meaning that they must have a portfolio and a distribution plan to help them make up where social security falls short.
6. Not Planning For The Premature Death Of Your Spouse
While both spouses are living, both will often be receiving a benefit. This can either take the form of both of both spouses claiming on their own records, or both spouses claiming on the records of one. When one spouse dies, however, one of those social security benefits will disappear. The surviving spouse will always continue to receive their household’s highest benefit, but one benefit will always disappear.
For example, consider Joe with a monthly benefit of $3,000, and Sally with a monthly benefit of $2,000. If Joe passes away, Sally will find her benefit increase to $3,000, but her $2,000 benefit will go away. Sally is now left with only $3,000 in monthly benefits when her and Joe used to receive $5,000, forcing her to rely on other financial sources (assuming they exist) to bridge the gap.
This is especially important for people with government pensions to understand, as their survivor’s benefits will likely be subject to an adjustment known as the Government Pension Offset (GPO), which will offset their survivor’s benefits by 2/3rds of their government pension.
Conclusion
Since decisions regarding Social Security are generally irrevocable, making the right ones is paramount. Due to the complexity of the program, however, mistakes are frequently made. By being aware of some of the most common pitfalls, you can make dramatic improvements to your retirement plan!
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