PRACTICE MANAGEMENT How Social Security Retirement Age Rules Impact Clients March 15, 2017 512 Views Changes can substantially reduce the value of delaying widow(er) benefits for surviving spouses. This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors). Under the original rules f or Social Security, workers became eligible f or a benef it upon reaching their f ull retirement age of 65, with a slight increase in benef its if the worker delayed until as late as age 70. However, the full-retirement age itself has always been a moving target. It was pushed from 65 to 67 in 1983, and Congress f requently raises the specter of pushing it out even later which, if acted on, could diminish the utility of a retiree delaying his/her Social Security disbursal. What follows is a look into how to navigate the knowns and unknowns of Social Security payouts. A Moving Target Under the original Social Security Act of 1935, workers had to reach age 65 to receive a f ull retirement benef it. This f ull retirement age, though commonly attributed to a similar old age social insurance program designed by Otto von Bismarck in Germany in 1889, was actually rooted in the f act that many state pension systems and also the then-recent Railroad Retirement Benef it system used age 65, and the Committee on Economic Security, which designed the U.S. Social Security system, decided to adopt what was already common practice. The f ull retirement age remained at age 65 until 1983, when the Social Security Trust was about to run out of money, which would have caused an immediate partial cut to benef its. The subsequent National Commission on Social Security Reform, also known as the Greenspan Commission after its chairman Alan Greenspan, recommended a series of adjustments to the system to extend its stability f or another 50 years. The end result was the Social Security Amendments Act of 1983, signed into law on April 20 of that year just a f ew months bef ore the Social Security Trust Fund would have run dry which made a wide range of changes to the system, including the increase of full retirement age from 65 to 67. To sof ten the impact of the increase, the Greenspan Commission recommended a phased approach over time. Everyone who was already within 20 years of f ull retirement age approximately age 45 or older at the time the law was passed would get to keep the original full retirement age of 65. Those who were age 44 or younger born in 1938 or later would have to accept a higher f ull retirement age, but the phase-in would occur gradually over a 22-year period, with an 11-year hiatus in the middle. 1
The end result was that only those aged 22 or younger in early 1983 born in 1960 or later would actually be subject to the new full retirement age of 67. Given these birth years, every prospective retiree since 2005, upon turning age 62 and becoming eligible for early retirement benefits, has had a full retirement age of 66 as someone who turned 62 in 2005 was born in 1943. However, the 11-year hiatus of f ull retirement age adjustments has now come to an end, as anyone turning 62 in 2017 was born in 1955, which means their f ull retirement age is no longer age 66. Instead, it is wait for it age 66 and two months. Difference Between Women and Men The significance of the full retirement age is not merely that it s the age at which retirement benef its become payable. Since 1956, women have been able to start benef its as early as age 62 implemented at the time because wives on average were three years younger than their husbands and wanted to retire and start benefits at the same time and the rule was expanded to allow men to retire early in 1961. However, to remain actuarially f air, Social Security stipulated that taking early retirement at age 62 would reduce benefits by 20%, which equates to 6.66% per year, or five-ninths of 1% for each month early. With the increase in f ull retirement age, though, it suddenly becomes possible to retire more than three years early. Accordingly, the rules were adjusted to provide that any f urther early benef its beyond the first three years would be reduced at an additional 5% per year, or five-twelfths of 1% f or each additional month. Consequently, in recent years when the f ull retirement age was 66, the total early benef its reduction was 6.66% per year f or the f irst three years early, and another 5% for the fourth year early, for a total reduction of 25%. Delayed Retirement Credits Similar to the downwards adjustment f or starting retirement benef its early, there s also an increase f or delaying retirement past f ull retirement age. Originally, these delayed retirement credits were 2
minuscule, at just 1% per year f or waiting, but 1977 Social Security amendments increased delayed retirement credits to 3% per year, and the 1983 Greenspan Commission amendments ultimately phased delayed retirement credits all the way up to 8% per year, or two-thirds of 1% per month, f or delaying past f ull retirement age. As a result, with a full retirement age of 66, the maximum delay to age 70 would result in delayed retirement credits of 8% per year x 4 years = a 32% increase. Notably, the 8% per year delayed retirement credits are simply cumulative, not compounded. Consequences The significance of the increase in full retirement age from 66 to 66 and two months is that trying to take benef its at 66 is actually an early benef its election, resulting in a 1.1% reduction f or starting payments two months bef ore f ull retirement age. For those who want to start as early as possible, at age 62, doing so is no longer a decision to take benefits four years early. Instead, it s four years and two months early, which means the age- 62 benef its reduction is now 25.83% instead of just 25%. Similarly, delaying to the maximum age 70 would not earn f our years worth of delayed retirement credits (DRCs), but instead only three years and 10 months of DRCs, for a total increase of 30.67% instead of the full 32%. The end result is that benefits can never quite be as high as they were before at the maximum, and at any given age Social Security benef its take a slight haircut. 3
Notably, the impact of a rising full retirement age will continue from here for several more years as well. As noted earlier, the full retirement age is scheduled to go all the way to age 67 over the next f ive years, such that those born in 1960 or later i.e., those who start turning 62 in 2022 will f ind when making their Social Security decisions that an age-62 start date is a f ull 30% reduction, while delaying to age 70 is only a 24% increase. Spousal and Survivor Benefits In addition to changes the consequences of taking early or late retirement benef its, the change in f ull retirement age also af f ects spousal and survivor benef its as well. In the case of spousal benef its, the standard rules stipulate that spousal benef its will be reduced by 8.33% per year calculated as 25/36ths of 1% per month f or the f irst three years, and 5% per year f or each additional year. 4
Thus, it was originally the case that taking spousal benefits at age 62 was just a 25% reduction at 8.33% per year for three years when the full retirement age was 65, but starting at age 62, there has been a 30% reduction f or the past decade, when the f ull retirement age was 66, and beginning in 2017 the age-62 spousal reduction will be 30.83%, climbing to a maximum reduction of 35% in 2022 f or those born in 1960 or later. When it comes to survivor benefits, though, the rules are slightly different. Survivor benefits can be claimed as early as age 60, and the maximum reduction for starting survivor benefits that early is always a flat 28.5% reduction, applied pro-rata from the maximum retirement age back to age 60. 5
Thus, in the original system when the f ull retirement age was 65, starting at age 60 was f ive years early, and the reduction was 28.5%/5 years = 5.7% per year, or 0.475% per month. At f ull retirement age of 66, starting at age 60 is six years early, so the reduction is 28.5%/6 years = 4.75%/year, or 0.396% per month. And when f ull retirement age ultimately goes to 67, the reduction will be 28.5%/7 years = 4.07% per year, or 0.339% per month. Notably, the end result of these rules is that for survivor benefits, it s not any worse to claim benefits at the earliest age 60 as the full retirement age increases unlike for retirement and spousal benef its. In f act, by stretching out the same reduction over a longer period, it actually lessens the monthly impact of starting early even as it increases the number of months that must be delayed to reach the f ull survivor benef it. 6
On the other hand, it s also important to recognize that full retirement age for survivor benefits is increasing on a dif f erent schedule than f ull retirement age f or retirement and spousal benef its. For those who were born in 1955, whereby the full retirement age is rising to 66 and two months, the full retirement age for survivor benefits remains age 66, and only rises to 66 and two months for those born in 1957. In turn, the full retirement age for survivor benefits isn t only age 67 for those born in 1962 or later as contrasted with retirement benef its, where f ull retirement age is 67 f or everyone born in 1960 or later. As a result, f or the next several years, prospective Social Security claimants will actually have to deal with two different full retirement ages: one for retirement and spousal benefits, and a slightly earlier and more f avorable f ull retirement age f or survivor benef its. Planning Implications Ultimately f or most retirees, there s nothing to be done about the changes in the f ull retirement age. They re a function of a law that was passed over three decades ago, which simply took until now to f inish their slowly phased implementation, based on the retiree s birth year. And obviously, there s no way to change your birth year; for better or worse, you get what you get from here. In addition, it s important to recognize that while the increase in f ull retirement age makes the adverse consequences of starting at age 62 a little more severe f or retirement and spousal benefits, and the upside of waiting until age 70 less advantageous for retirement benefits, it doesn t materially change the relative value of waiting, and the breakeven period. For instance, an individual with a $1,000 per month retirement benef it at f ull retirement age of 66 could have enjoyed $750 per month at age 62, representing a 25% reduction, or $1,320 per month at age 70, a 32% increase. In the future, if that individual s full retirement age goes to 67, it will be $700 per month at age 62, representing a 30% reduction for five years early, and $1,240 per month at age 70, a 24% increase f or waiting three years. However, in both cases, it s still an increase of about 76% to wait from age 62 to age 70, and the breakeven period is still about the same 20-year time period. Again, the primary impact of the 7
changing f ull retirement age is not actually to alter the value of waiting; it s just to slightly reduce overall benefits. On the other hand, when it comes to survivor benef its, the changes to f ull retirement age as it begins phasing in, in another two years lessens the reduction f or starting benef its early, which actually does make it less valuable to delay. In essence, if it takes another year of waiting to undo the f ull 28.5% early reduction, then it takes even longer to reach the breakeven period where the higher benef its outweigh the cost of waiting. Of course, it s notable that when survivors have their own lesser retirement benef it, it may be advantageous to wait on survivor benef its until f ull retirement age, and claim individual benef its in the meantime, which can drastically reduce the breakeven period. Nonetheless, at least on a standalone basis and when the earnings test won t apply, later f ull retirement ages reduce the value of delaying survivor benef its, quite substantially. In most situations, though, the key is simply to recognize the change that is underway, and that after more than a decade of the standard age 66, this is no longer the case, nor is it standard that starting at age 62 reduces benefits by 25%, nor that waiting until age 70 increase benefits by 32%. Instead, for those turning 62 this year, the shift is on, with full retirement age of 66 and two months, a 25.8% haircut f or starting early, and a 30.7% increase f or delaying. And the transition will continue until 2022, when all retirees born 1960 or later have a f ull retirement age of 67, a 30% maximum reduction f or starting early, and only a potential of 24% in delayed retirement credits f or waiting until age 70. And in the case of survivor benef its, the transition will continue even longer, as f ull retirement age becomes disjointed until 2024. by Michael Kitces Michael Kitces, CFP, a Financial Planning contributing writer, is a partner and director of wealth management at Pinnacle Advisory Group in Columbia, Maryland; co-founder of the XY Planning 8
Network; and publisher of the planning blog Nerd s Eye View. Follow him on Twitter at @MichaelKitces. The inf ormation provided is f or general inf ormation purposes only and is not intended to be legal, tax or investment advice. The inf ormation contained herein has been provided by sources other than Lord Abbett which are believed to be reliable; however Lord Abbett cannot guarantee the accuracy or completeness of this inf ormation. Investors should carefully consider the investment objectives, risks, charges and expenses of the Lord Abbett Funds. This and other important information is contained in the fund's summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, you can click here or contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388. Read the prospectus carefully before you invest or send money. Not FDIC-Insured. May lose value. Not guaranteed by any bank. Copyright 2018 Lord, Abbett & Co. LLC. All rights reserved. Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC. For U.S. residents only. The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances. 9