Navigating Social Security

Transcription

1 EVENT RECAP Navigating Social Security FOR CURRENT AND PROSPECTIVE CLIENT USE Photo Credit: Steve Friedman On February 2, 2016, Gerstein Fisher and approximately 200 clients, financial advisors, and friends gathered to discuss the topic of Social Security. The evening s featured speaker was award-winning journalist and Social Security expert Mary Beth Franklin. With recent rule changes phasing out key claiming strategies, the time is now for individuals to ensure they are armed with the information they need to maximize their Social Security benefits. What follows is a summary of key themes we explored. Navigating Social Security Today: Considerations for Investors Gregg S. Fisher, CFA Chief Investment Officer, Gerstein Fisher Social Security recently celebrated its 80 th anniversary. When it was signed into law in 1935, only about 2% of the American population was over the age of 65. In 2010, that figure stood at 13%, and by 2060 it is projected that 22% of Americans will be over the age of 65. Even if you re not about to reach retirement age, Social Security is a topic well worth understanding, since it may impact how you invest, where and how long you work, when to retire and even where to live in retirement. The more you can plan ahead and be strategic about your choices when the time comes, the better. Market Context Social Security is an important topic, but it s also a complex one and can be challenging to navigate. It requires making decisions and choices that will greatly impact your financial well being, all within a framework that s in flux, given that some key rules have changed. Let s take a step back and look at the market context within which we re thinking about Social Security. As shown in Exhibit 1, if you put a dollar into US large cap Exhibit 1: Growth of a $1 Investment in S&P 500 (Jan. 2, 1995 Jan. 31, 2016) S&P 500 Total Return 300% 250% 200% 150% 100% 50% 0% 50% Dot-Com Boom Post-9/11 Pre-Crisis 259% Sources: Standard & Poor s, Gerstein Fisher Research -44% 108% Global Financial Crisis 100% $ Jan Mar.2000 Apr Sep.2002 Oct Oct.2007 Nov Feb.2009 Mar Dec.2014 Jan Jan.31, % Recovery from % Market Volatility -3.65% $7 $6 $5 $4 $3 $2 S&P 500 Growth of $1

2 stocks (S&P 500) in 1995 and held it through today, you d have about $7, an annualized return of around 9%. A couple of things stand out in examining this chart. First, equities are highly volatile. Second, investors are rewarded over this long time horizon for sticking with their equity allocations. From a behavioral standpoint, however, the latter can be difficult to do. But look at the recovery from the market bottom in March 2009 investors who sold on fear at the bottom missed out on a lot of return potential in the ensuing years. Indeed, we believe that the biggest mistake investors tend to make is selling their investments at a bad time panicking when the market is down and selling at or near the bottom. This is why, in any market environment, we recommend keeping enough liquidity on the side to get you through rough patches without having to sell low. As it relates to Social Security, when markets are volatile, the value of a fixed stream of income becomes very meaningful. Additionally, when you consider the prevailing near-zerointerest-rate environment, investors are challenged to find yield in the current market (see Exhibit 2). This is yet another factor that could influence when an individual might want or need to start claiming Social Security benefits. Exhibit 2: US Government Bond Yields (Jan. 2, 1995 Jan. 31, 2016) (%) US 10-Year Gov t Bond Yield Sources: Bloomberg, Gerstein Fisher Research Beyond what s going on in the financial markets, other factors are elevating the importance of having a sound Social Security strategy in place. Chief among these are ever-lengthening life expectancies in this country. Longevity risk has always been a risk factor for investors, and one could argue this risk is only increasing as Americans are living longer than ever in history. And savings rates in the United States remain low, as seen in Exhibit 3. If those savings are going toward higher consumption (which the record number of self-storage facilities in the country seems to indicate they may be), one could argue this is actually a good thing for economic growth since about 70% of our GDP is driven by consumer spending. The downside is that people have less in savings to stretch over their (now longer) retirement lifetimes. Exhibit 3: US Personal Saving Rate 12-month Moving Average (Jan Dec. 2015) (%) US Personal Savings Rate 12-Month Moving Average Source: Federal Reserve Taking Control Average life expectancies and national personal savings rates are not within our individual control, but there are things we can control, and we would argue that these should be areas of focus for investors. A simple schematic explaining this concept is presented in Exhibit 4. Except as voters, we can t control government and government policies, and while there are things we can do to influence our own longevity and certainly our employment, we arguably have the greatest control over things like: how much we spend, save, invest and, to a certain extent, how much we pay in taxes on investment gains. 2 Gerstein Fisher

3 Exhibit 4: Make the Most of the Things You Can Control Exhibit 5: Increase in Cost of Living at Different Inflation Rates (assuming annual cost of living starts at $10,000 in year 1) Retirement 30,000 Cost of living triples in 18 years if inflation is 7% Market and Government Policies Out of Your Control Longevity and Employment Somewhat Under Your Control Investment/Saving and Spending Under Your Control Cost of Living ($) 20,000 Cost of living triples in 57 years if inflation is 2% 2% 3% 4% 5% 6% 7% With respect to your investments, we would encourage diversification across asset classes and market sectors. As noted earlier, having 6-12 months of living expenses set aside for emergencies is also a sound strategy. And just being invested in financial assets like stocks is a great way to protect yourself from inflation. Inflation is a very real wealth hazard for any of us who expect to continue to buy things five or ten or thirty years down the road. Here is a simple example: a Hershey bar that costs me $1.29 today cost only 35 cents thirty years ago, in That s about a 5% inflation rate. So translate that to a person spending about $100,000 today and what they would need to sustain that same level of spending 30 years from now, and it would calculate to $300,000. Exhibit 5 demonstrates the effects of different rates of inflation on spending power. So in order to keep up with rising prices, your investments need to be earning some kind of return above the essentially zero percent you d currently get if your savings were all locked up in a savings account in cash. Indeed, inflation is one of the reasons we invest to begin with. Recall Exhibit 1 and the approximately 9% annualized return from US large cap stocks earned over 20 years. Certainly we can t always expect that level of return, and an individual s return will also depend on when she got into and out of the market, but over most long time horizons, investors have been rewarded for incurring the risk associated with holding assets like equities. 10, Sources: US Bureau of Labor Statistics, Gerstein Fisher Research The good news about your Social Security benefits is that they are adjusted for inflation through what is referred to as the Cost-of-Living Adjustment, or COLA. This is calculated based on the Consumer Price Index (CPI), a key government measure of inflation. Going back to the things over which you have control, one important decision individuals must make is the age at which they file for their Social Security benefits. There are many dimensions to this question, but at a high level, the earlier you file, the less of a long-term benefit you will receive. But just as no financial decision is black-andwhite, any individual s decision over when to file will be influenced by such questions as: does my need for cash flow today exceed the security I will feel knowing I will have more later? Do I plan on continuing to work, even part time? Can my spouse begin receiving benefits without penalty? Optimizing your Social Security benefits is as important as it is complex. We encourage individuals to start thinking about their strategy, and to do so in the broader view of their total financial picture. We encourage financial advisors to help in this process, and to become well versed in the intricacies of the rules surrounding Social Security so that they can help their clients make the most of this very critical piece of the retirement income puzzle. Year Navigating Social Security Event Recap 3

4 How to Maximize Social Security Benefits Now Mary Beth Franklin, CFP Contributing Editor, Investment News Featured guest speaker Mary Beth Franklin outlined strategies individuals can use to maximize their Social Security benefits in a number of scenarios and discussed two specific claiming strategies that are being phased out for millions of Americans. The section below summarizes highlights of the discussion. Q: Last year Social Security celebrated its 80 th birthday. Why is it still so important today? Social Security is the single largest source of income for the majority of Americans 65 and older, so deciding when and how to claim benefits is one of the most important retirement-income decisions. I try to teach people ways to optimize their Social Security benefits because in this era of disappearing pensions, erratic stock markets, and interest rates that are essentially zero, for many older people Social Security is the only source of guaranteed income for the rest of their lives. You can t outlive it. Social Security is like an annuity or income guarantee that covers fixed costs in retirement. Q: How early can you file for Social Security benefits? Anybody can collect a Social Security benefit as early as age 62. But what you may not realize is that if you do so, your benefits are going to be reduced by 25% or more for the rest of your life. If you wait to claim benefits until your full retirement age, or FRA, which is currently 66 for anyone born from 1943 through 1954 (and 67 for those born after 1960), you get 100% of the benefits you have earned. Unfortunately, many people grab benefits as soon as they can, at 62, and think that at 66, magically, they can switch and get a full benefit. But that s not true if you take it early, the benefit is permanently reduced. Yet more than 50% of Americans take Social Security at 62. People need to understand that deciding when to retire and when to claim Social Security benefits are two separate decisions that don t need to occur simultaneously. Exhibit 6: Reduction in Lifetime Social Security Benefit Due to Filing at Age 62 Birth Year Full Retirement Age Benefit Reduction at % and 2 months 25.83% and 4 months 26.67% and 6 months 27.50% and 8 months 28.33% and 10 months 29.17% 1960 and later % Increasing the FRA to 67 increases the reduction for claiming early at 62 to 30% and reduces the amount of maximum delayed retirement credits at age 70 to 24%. Q: Can you claim early if you are still working? You can, but what many people don t realize is that if you claim Social Security benefits before your full retirement age and you continue to work you re going to lose benefits, at least temporarily, to an earnings cap, if you make too much money. And Social Security defines too much money as $15,720 a year. If you claim Social Security benefits before your full retirement age and continue to work, the government is going to take back a dollar in benefits for every $2 you earned over $15,720 a year. So if you make $47,000 or more, all of your benefits are gone. They re not gone forever this earnings cap is temporary. When you get to your full retirement age of 66 the earnings cap goes away completely. But there s a problem. If, for example, while working from age 62 to 66 you gave back 24 months of benefits due to the earnings cap, your initial benefit cut of 25% from claiming 4 years early is reduced to about 13 % because the two years of benefits you forfeited to the earnings cap are reinstated at your full retirement age. It s important to remember that this reduced benefit will impact your surviving spouse should you die prematurely. My feeling is if you plan to keep working, in most cases collecting at 62 just doesn t make sense. Q: Is there an advantage to waiting until you re older than full retirement age to take benefits? Waiting until age 70 will get you an extra 8% per year between the ages of 66 and 70. The difference between claiming a reduced benefit at 62 where you d get 75% of this benefit versus waiting until 70, when you get 132% of your full retirement age benefit, is an increase of 76% in 4 Gerstein Fisher

5 your Social Security income for the rest of your life. That s a big difference. And having a bigger benefit means that each year when there s a cost of living adjustment it s going to be a bigger dollar amount because it s applied to a larger base benefit. For people who are 66, healthy, likely to live a long time and who can afford to delay, waiting until 70 may be a very beneficial strategy. Many people think they re not going to be around a long time, but nursing homes are filled with a whole lot of people who never thought they d be there. The Social Security Administration says the average life expectancy for a 65-year old man is 84 and for a woman it s 86. But those are median ages, so half of people are going to live longer than that. If you re collegeeducated and white collar, the likelihood is you re going to live a very long time. For some people, the question may be, do I want to take that benefit at 62 so I can buy a boat or do I want to take it at 70 so I know I can eat at 85? For others, it may be more of a tradeoff between greater financial security later and being able to pay the bills now. These are personal and household decisions that depend on factors like health and cash flow, but they are very important to think about. Q: What are some strategies married couples can use to get the most out of their Social Security benefits? In my view, the main goal for a married couple is maximizing the survivor benefit. In most cases, it makes sense for the higher-earning spouse to delay claiming Social Security for as long as possible (until 70, if possible), locking in not just the maximum retirement benefit for the couple during their lifetime but also assuring the largest possible survivor benefit for the remaining spouse after the first spouse dies. Also, because the lower-earning spouses particularly wives who are the same age or younger than their husbands are likely to outlive their spouses, it often makes sense for them to collect reduced benefits as early as 62, if they are no longer working, to bring some cash flow into the house, and then step up to a larger survivor benefit later. A survivor benefit is worth 100% of what the deceased worker was receiving, or was eligible to receive, at the time of death if the surviving spouse collects at his or her full retirement age. In other words, I am entitled to a retirement benefit on my own work record and if I m a surviving spouse, I can choose to collect one benefit first and switch to the other one later if it s bigger. But if the higher earner collects reduced Social Security benefits early, not only will their retirement benefits be permanently reduced, but they may unwittingly be sentencing their surviving spouse to a lifetime of reduced benefits. By the way, everything I have just said for married couples now applies to married same-sex couples as a result of the Supreme Court s decision in June Q: What if one of the spouses never worked? If it s the wife, for example, then she wouldn t have a Social Security benefit on her own record. But the fact that she s married to someone who does means she s entitled to a spousal benefit. When they created this spousal benefit the idea was that when a worker stops working, Social Security basically becomes like a pension, and because the couple s household income is reduced, the non-working spouse should be entitled to a spousal benefit. A spousal benefit can be worth up to half of the worker s benefit amount if the person collecting it is at full retirement age (66 today). The challenge is that she can t get a spousal benefit until her husband takes an action. He either has to claim a benefit so that she, in turn, can receive a spousal benefit, or if the husband is smart he would want to file and suspend at 66 to trigger a benefit for his spouse while his own benefit continues to grow up until age 70. File and suspend has been a powerful strategy for married couples, but it s going away. Q: Talk a bit more about the filing strategies that are going away and who is affected by these changes. Social Security rules are changing this year, and two critical claiming strategies are disappearing. The first is called file and suspend. Under current law, if you wait until your full retirement age (currently 66), you can file for your benefits but ask Social Security not to pay you yet. Let s say the older spouse is the husband, 66, and his wife is 65. Once he files, his wife can collect spousal benefits (one-half of his) on his benefit while his benefit keeps growing by 8% a year up to the maximum age of 70, which is a 32% increase in guaranteed benefits. File and suspend also triggers a benefit for minor dependent children. But this magic strategy is disappearing under the new rules after April 29, If you re 66 or older by April 30, you can still file and suspend under the old rules, but you must do so by April 29, The other claiming strategy that is expiring is the restricted claim for spousal benefits. With this strategy, when you turn 66, you can claim the spousal benefit only Navigating Social Security Event Recap 5

6 (assuming your spouse has claimed his or her benefit) while your own benefit keeps growing 8% a year until age 70. Only people who are 62 on or before January 1, 2016 can still use this strategy. Interestingly, a divorced person who s 62 by January 1, 2016 can also claim spousal benefits on an ex-spouse, even if the ex-spouse has not yet claimed benefits or has re-married. This is something many people aren t aware of. Q: What are your rights to a former spouse s benefits if you are divorced? The rules state that as long as you were married for at least 10 years, have been divorced for at least two years and are currently single, you can collect on your ex-spouse s benefit on his or her earnings record even if he or she has not yet claimed benefits as if you were still married. This is true whether your spouse has remarried. But all of the other basic rules apply: if you claim before your full retirement age, your benefits are permanently reduced. Q: Are Social Security benefits taxed? Yes, Social Security benefits are taxable, and at very low income thresholds. If you are single and your adjusted gross income (AGI) is more than $32,000, up to 85% of your social security benefits are going to be taxed at your marginal tax rate. If you re married and your AGI is over $44,000, up to 85% of your benefits will be taxed. The good news is it s still a better deal than taking money out of an IRA or a 401(k), which is 100% taxable. This is why I say people need a diversification strategy for taxability of income in retirement. Q: Could you elaborate on that? Most people make the mistake of putting all of their retirement savings in tax-deferred retirement accounts. This is great while you are in accumulation mode, but in retirement, every dollar that comes out is taxed at ordinary rates. So just like diversifying assets while you save for retirement, it s important to consider diversifying the taxability of your retirement accounts. For example, money in a Roth IRA comes out tax-free; HSA money comes out tax-free for medical expenses; a loan or distribution from a cash-value life insurance policy doesn t count as taxable income; taxable brokerage account stock holdings are taxed only on capital gains, 20% at worst for assets held long term; with Social Security, at worst, 85% of income is subject to taxation. I would encourage everybody to create pots of money that are taxed differently so that each year you can draw from different pots. That way, you not only hold down your income taxes in retirement, but also how much you re going to pay in Medicare premiums. The way this works is that a chunk of money comes out of your Social Security benefits each month to pay for Medicare B premiums. Since it s means-tested, when your Modified AGI surpasses $85,000 for a single person, $170,000 for a married couple, you start paying more and more in Medicare B premiums. An account diversification strategy will only become more important since Medicare premiums will rise dramatically for many retirees in Q: If a person has already filed to claim benefits, can he change his mind? Yes, this is what I call a do-over strategy. Within the initial 12 months of first claiming benefits, you have the right to change your mind and withdraw your application. But there is a catch: if you do that, you have to pay back all of the benefits you received, and if anyone else is collecting benefits on your record, like a spouse or a child, you need to pay those back, too. So why would someone want to do this? It s because it wipes the slate clean as if you had never collected Social Security benefits so that at a later date and an older age you can collect a larger benefit. If you miss that 12-month window, there is Exhibit 7: Medicare Premiums at Various Income Levels File individual tax return File joint tax return If your 2014 income was Your Medicare B premium in 2016 is <$85,000 <$170,000 $ $85,001 - $107,000 $170,001-$214,000 $ $107,001-$160,000 $214,001-$320,000 $ $160,001-$214,000 $320,001-$428,000 $ >$214,001 >$428,000 $ Additional surcharges Apply to Medicare Part D Source: Social Security Administration 6 Gerstein Fisher

7 another opportunity, but you have to wait until the magic age of 66, at which point you could suspend your benefit, take nothing for up to four years, but in the interim your benefit is going to grow by 8% a year. Let me give you an example of who might want to do that. Let s say the husband, the higher earner, decided to collect benefits at 62 because he could; it probably didn t occur to him that he was getting 75% of his benefit and that if he dies that s probably what his widow is going to get stuck with since a survivor benefit is 100% of what the worker was entitled to or was collecting at time of death. But let s say at the age of 66 he suspends his benefits. He wouldn t get any benefits for four years, but it grows at 8% a year. Now, if you multiple his original benefit at 75% times 1.32, you ll come up with 99%. He has effectively restored his full retirement age amount, and his widow will thank him for that. Navigating Social Security: Key Takeaways When it comes to investing, it s smart for investors to focus on factors they can control. The market is volatile and often unpredictable, but you do have control over such things as how much you spend, save, and invest. You also have control over when you take your Social Security benefits, and this is a critical decision as more people are living longer and needing to rely on Social Security as a critical stream of income in retirement. Optimizing Social Security benefits is as important as it is complex. It is never too early to start thinking about your strategy, and this should be done in the broader context of your total financial picture. Working with a financial advisor who is knowledgeable about Social Security rules can be helpful in this regard. You can collect Social Security as early as 62, but there are drawbacks to filing before full retirement age (currently 66). Chief among these is a reduction in the amount of the benefit you will receive for the rest of your life. Circumstances such as the need for current income may compel an individual to file early, but this decision should be made while weighing the longer-term consequences. For married couples, Social Security claiming strategies should be approached as household decisions. When two working spouses have their own work records, it s important to coordinate filing strategies so as to maximize benefits. This is especially important as it relates to the survivor benefit. Two key claiming strategies are being phased out. Some individuals can still use them, but time is running out. File and suspend and filing a restricted claim for spousal benefits only are two powerful strategies that are going away. If you are 66 on or before April 30, 2016, you can still file and suspend. If you are 62 on or before January 1, 2016, you can still receive spousal benefits only. It is generally not advisable to collect early if you are still working. If you continue to work after filing and beginning to receive Social Security benefits, you will give back $1 to the government for every $2 you earn over $15,720 per year due to an earnings cap. (The cap goes away when you reach full retirement age.) It s smart to diversify the taxability of your sources of retirement income. By creating pots of money that are taxed differently (a qualified retirement plan, a brokerage account, your Social Security benefits, e.g.), you can draw from different pots as you need money in a way that minimizes your overall tax liability. Mary Beth Franklin s latest ebook, Maximizing Social Security Retirement Benefits, can be purchased at www. investmentnews.com/mbfebook. Navigating Social Security Event Recap 7

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