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Most people – maybe even most accountants – think of Social Security as just a government retirement plan. But perhaps just as important are the survivor benefits, the payments made to survivors following the death of the insured beneficiary.
These payments can be an important element in determining the total recurring cash flow for a surviving spouse, who can receive the amount to which the deceased spouse was entitled. This amount will be 100 percent of the deceased's benefit, if taken after the survivor reaches his or her full retirement age (FRA) – age 66 for those born between 1943 and 1954. In these days when women are increasingly likely to be entitled to Social Security benefits on their own, taxpayers need to develop a strategy to coordinate and maximize these two distinct payouts.
Survivor benefits are based on the insured worker's "primary insurance amount" (PIA) – monthly payment – on date of death. To be eligible for a survivor's benefit, the survivor must be at least age 60 (age 50 if disabled), have been married to the deceased for at least nine months before death occurred, or be the parent of the insured's child. Normally the remarriage of the survivor would cancel collection of a survivor's benefit, but doing so after the age of 60 is allowed. This applies to surviving divorced spouses as well, as long as their union lasted 10 years.
Timing Is Everything
Postponing collection of Social Security until after attainment of FRA allows the beneficiary an annual increase of 8 percent in the amount ultimately received. Survivor benefits reflect delayed credits, meaning that if the deceased spouse had deferred taking Social Security, the higher benefit will be passed on to the survivor.
Here's an example: John and Jane are married. John's FRA is 66. At 66, John has a benefit based on his earnings record of $2,000. If John delays collection of his benefit, he receives an 8 percent annual credit, so at 67 his PIA is $2,160. If he dies at this age, Jane will "step in" and receive $2,160.
People can choose to collect Social Security before FRA, but benefits will be reduced. At age 62, the earliest age to collect on your own record, the benefit is pared by 25 percent. A surviving spouse is able to collect a reduced benefit as early as age 60; the benefit is cut by 0.295 percent of the deceased's PIA.
It is noteworthy that surviving spouses have the option of switching from a benefit on their own record to a survivor's payout (or vice versa) even if benefits are taken before FRA. This option to convert is a powerful financial planning tool not available to those taking spousal benefits before FRA. A strategy to optimize payouts is to postpone the greater of the two.
Here's an example of how that might work: Jane is a 62-year-old widow with her own benefit of $1,200 and a survivor's benefit of $2,000. Jane could file a restricted application to take her own reduced benefit of $900 [$1,200 x 0.75] and convert to a survivor's benefit ($2,000) at 66.
But what if the payouts are of a similar amount?
Here's how that could play out: May is a 60-year-old widow with her own benefit of $2,000 and a survivor's benefit of $1,800. She could apply for the reduced survivor's payout of $1,287 [$1,800 x 0.715] then at 66 switch to her own ($2,000) or, by waiting, receive even more by virtue of delayed credits. Accountants should note that an earnings test is applied to a survivor's benefit, and a person collecting before FRA will have payouts decreased: The excess earnings threshold for 2014 is $15,480. The amount withheld is not forfeited but added back at FRA.
The number of people taking Social Security benefits at the earliest possible moment is decreasing, a positive trend in light of advanced life expectancies for both men and women. Decisions regarding when to begin to receive Social Security benefits have a lifelong impact. When people collect as early as possible, they miss out on opportunities available if they had waited until FRA. If the goal is to minimize the risk of outliving your money, you will want to delay claiming as long as possible. Provided an individual satisfies his or her life expectancy, waiting usually results in the optimal payout design.
About the author:
Daniel G. Mazzola, CPA, CFA, is an investment advisory representative with American Portfolios Advisors Inc. He is a Chartered Financial Analyst, Certified Public Accountant, and Certified Financial Planner.