Social Security planning after the Bipartisan Budget Act

Social Security White paper NATIONWIDE RETIREMENT INSTITUTE The Nationwide Retirement Institute provides practical thought leadership and comprehensive solutions to financial advisors and their clients. Through education and insights, client-ready tools and consultative support, we break down and simplify complex retirement challenges to help advisors and clients plan for a more secure financial future. Social Security planning after the Bipartisan Budget Act Joe Elsasser, CFP Financial Planner, Software Creator Prepared for Nationwide in April 2016 Joe Elsasser is the creator of Social Security Timing, a software program that helps over 1,500 advisory firms, plus many large institutions across the country, identify optimal Social Security claiming strategies. He s the co-author of Social Security Essentials: Smart Ways to Help Boost Your Retirement Income, and he s the Managing Partner of Sequent Planning, LLC, an Omaha-based Investment Advisor firm. Joe has been featured or quoted in the Wall Street Journal, USA Today, Kiplinger and several other national publications. Gain an understanding of the opportunities and pitfalls in Social Security claiming strategies. Successful advisors recognize that times of change create opportunities to deliver value, strengthen client relationships and build new center-of-influence relationships. The Bipartisan Budget Act of 2015 (BBA) creates a new tension between spousal and survivor benefits and highlights often missed opportunities for widows. Further, these changes create an environment in which the retirement earnings test will play a central role in a far greater percentage of Social Security decisions. This white paper will explore the changes under the BBA, the importance, mechanics and impact of the retirement earnings test under the new rules for people who are married or divorced and the parallel opportunities for widows that remain. Savvy advisors will recognize the opportunity to deliver value to clients and professional relationships in a time when the average advisor loses focus. 1

Bipartisan Budget Act of 2015 The BBA made sweeping changes to Social Security claiming rules for retirees surrounding the Restricted Application and the Voluntary Suspension. To understand the rules after the changes, it s important to understand some Social Security basics. For most people who are married or have been married (divorced or widowed), there are three major categories of benefits: retirement, spousal and survivor. 1 Getting the most from Social Security means coordinating these classes of benefits in the context of the rules and a client s overall financial situation. Retirement benefits The retirement benefit is a benefit based generally on a worker s highest 35 years of adjusted earnings. 2 A progressive formula, designed to replace a higher percentage of pre-retirement earnings for lower wage earners, is then applied. The result is called a Primary Insurance Amount (PIA). The PIA is the benefit amount one receives if retirement benefits are elected at Full Retirement Age (FRA), which is 66 for people born between 1943 and 1954, gradually increasing to 67 for those born in 1960 and later. If retirement benefits are elected prior to FRA, a reduced monthly benefit is received, and if they are delayed past full retirement age, a greater monthly benefit is received. For someone whose FRA is 66, electing retirement benefits at 62 would result in a 25% monthly benefit reduction, and electing at 70 results in a 32% increase. Therefore, someone who delays claiming from 62 to 70 can increase their own retirement benefit by 76%. This increase was legislatively set to be fair in 1983, an era of much higher interest rates and lower life expectancies. The typical client of a financial advisor has an even longer life expectancy the average life expectancy has increased faster for higher wage earners than lower wage earners. 3 Assuming someone lives to be 85 years old with a PIA of $2,000, the additional value by delaying from age 62 to 70 in today s interest rate environment is $42,128. 4 Present value of benefits if taken at 62 Present value of benefits if taken at 70 $379,788 $421,916 $42,128 Spousal benefits Additional value due to delay Spousal benefits are one form of auxiliary benefits that are payable to dependents of someone entitled to a retirement benefit. The most common auxiliaries are spouses and ex-spouses, but dependent children and disabled adult children are other possible auxiliaries. In general, an auxiliary benefit is 50% of the worker s PIA. Spouses receive a reduction if a spousal benefit is received prior to FRA, but do not receive an increase for delay past FRA, so delaying a spousal benefit past 2 FRA simply represents lost checks. One of the most common mistakes advisors make in understanding spousal benefits is to believe that the spousal benefit is based on the worker s retirement benefit. It is not. Instead, it is based on the PIA of the worker, so the spousal benefit amount is not impacted by whether the worker claims early or delays claiming. In other words, a worker with a $2,000 PIA would receive $1,500 if he elected at 62, or $2,640 if he elected at 70. His spouse can collect a maximum benefit of $1,000 based on his work whether he elects early or delays makes no impact on her benefit amount. The timing of his claim does impact her eligibility, as she is not eligible for a spousal benefit until he has claimed his retirement benefit. Let s assume we have a client couple, John and Mary, who are both age 62. To keep the example relatively simple, we ll assume Mary spent less than 10 years in the workforce and does not have a benefit based on her own work. If John s goal was to create the largest possible monthly retirement benefit, he would delay benefits until he is age 70, as outlined above. However, delaying John s retirement benefit creates tension with Mary s spousal benefit. In order for Mary to be eligible to claim a spousal benefit, John must be entitled to a retirement benefit, meaning he must have filed. John s decision to delay to 70 eliminates eight years of spousal benefits for Mary, and only the first four of the eight years of delay would receive increases in the monthly spousal benefit amount. Thus the increase in lifetime value by John s delay from 62 to 70, which is $42,128 5 as outlined above, must be weighed against the reduction in value of spousal benefits. In this case, the reduction in the value of spousal benefits is $17,417 due to the missed spousal benefit. Present value of Mary s spousal benefits if taken at 62 Present value of Mary s spousal benefits if taken at 70 Additional value due to delay $177,234 $159,817 ($17,418) Prior to BBA s April 29, 2016 6 deadline, this tension could be resolved by using a technique called the Voluntary Suspension. Under the old rules, John would simply have filed for benefits, which would have opened up Mary s eligibility to claim spousal benefits, then immediately requested his benefits be suspended. He could capture the extra $42,128 without sacrificing spousal benefits. In fact, Mary could have elected spousal benefits at 66, improving the value of her spousal benefits by $28,525 over claiming at 62. After April 29, 2016, John still has the option to suspend, but during the suspension, Mary would not receive a spousal benefit. This change to the law was significant because it means that strategies that were once reasonably clear will now have to be weighed with additional considerations. These considerations will be unique to each couple based on the relative benefit amounts and ages.

Survivor benefits Unlike spousal benefits, which are based on the PIA of the worker, survivor benefits are based on the actual amount the deceased worker was receiving, including any reductions for early claiming or credits for delayed claiming. In the example of John and Mary, If John takes benefits at 62 and predeceases Mary, he will have permanently reduced the amount Mary can receive as a survivor benefit. If John elects at 62, he would receive 75% of his PIA while he is alive, but Mary s survivor benefit would be 82.5% of John s PIA due to a provision called the Widow Limit (RIB-LIM 7 ). Assuming life expectancy of 85 for John and 90 for Mary, the value of delay from 62 to 70 in the form of the survivor benefits would be $48,674. Advisors should be aware of the financial value of the survivor benefit, but also the emotional value of the increased income security for the widow. Combined value Mary s survivor benefits; John files early at 62 85 $16,484 $26,375 86 $16,354 $26,165 87 $16,224 $25,958 88 $16,095 $25,752 89 $15,967 $25,548 $81,124 $129,798 Mary s survivor benefits; John files at 66, FRA The difference between survivor benefits for filing early vs. waiting until FRA = $48,674 When we combine the value of the options for John and Mary, assuming life expectancies of 85 and 90, we see a positive impact of John s decision to delay from 62 to 70 of $73,385. From this perspective, delay makes sense. Since these amounts are calculated in present value, executing this Social Security strategy is equivalent to adding $73,385 to the client s portfolio today. John s RIB at 62 Mary s Spousal at 62 Mary s Survivor John s RIB at 70 Mary s Spousal at 70 Mary s Survivor 62 $18,000 $8,400 63 $17,857 $8,333 64 $17,715 $8,267 65 $17,575 $8,202 66 $17,435 $8,136 67 $17,297 $8,072 68 $17,160 $8,008 69 $17,023 $7,944 70 $16,888 $7,881 $29,724 $11,259 71 $16,754 $7,819 $29,488 $11,170 72 $16,621 $7,757 $29,254 $11,081 73 $16,489 $7,695 $29,021 $10,993 74 $16,359 $7,634 $28,791 $10,906 75 $16,229 $7,573 $28,563 $10,819 76 $16,100 $7,513 $28,336 $10,733 77 $15,972 $7,454 $28,111 $10,648 78 $15,845 $7,395 $27,888 $10,564 79 $15,720 $7,336 $27,667 $10,480 80 $15,595 $7,278 $27,447 $10,397 81 $15,471 $7,220 $27,229 $10,314 82 $15,348 $7,163 $27,013 $10,232 83 $15,227 $7,106 $26,799 $10,151 84 $15,106 $7,049 $26,586 $10,070 85 $16,484 $26,375 86 $16,354 $26,166 87 $16,224 $25,958 88 $16,095 $25,752 89 $15,967 $25,548 $379,788 $177,234 $81,124 $421,916 $159,817 $129,798 3

John and Mary s total benefits with file at 62 strategy John and Mary s total benefits with file at 70 strategy $638,146 $711,531 Difference in value of strategy $73,385 In this case study, we ve compared 62 to 70, which demonstrates a significant increase in value; however, because of the unique circumstances of this client case, when we look closer, we see that the entire value of delay is captured between age 62 and 66 and delaying to 70 actually reduces the lifetime value of the strategy by about $4,082 (due to the sacrifice in spousal benefits between age 66 and 70). John s RIB at 66 Mary s Spousal at 66 Mary s Survivor John s RIB at 70 Mary s Spousal at 70 Mary s Survivor 62 $0 63 $0 64 $0 65 $0 66 $23,247 $11,624 67 $23,063 $11,531 68 $22,880 $11,440 69 $22,698 $11,349 70 $22,518 $11,259 $29,724 $11,259 71 $22,339 $11,170 $29,488 $11,170 72 $22,162 $11,081 $29,254 $11,081 73 $21,986 $10,993 $29,021 $10,993 74 $21,811 $10,906 $28,791 $10,906 75 $21,638 $10,819 $28,563 $10,819 76 $21,467 $10,733 $28,336 $10,733 77 $21,296 $10,648 $28,111 $10,648 78 $21,127 $10,564 $27,888 $10,564 79 $20,960 $10,480 $27,667 $10,480 80 $20,793 $10,397 $27,447 $10,397 81 $20,628 $10,314 $27,229 $10,314 82 $20,464 $10,232 $27,013 $10,232 83 $20,302 $10,151 $26,799 $10,151 84 $20,141 $10,070 $26,586 $10,070 85 $19,981 $26,375 86 $19,823 $26,166 87 $19,665 $25,958 88 $19,509 $25,752 89 $19,354 $25,548 $411,521 $205,760 $98,332 $421,916 $159,817 $129,798 Combined benefits at 66 $715,613 Combined benefits at 70 $711,531 Difference in benefits ($4,082) Many clients will determine that the emotional value of the survivor benefit protection is worth the slight reduction in lifetime value due to the additional delay from 66 to 70. Others will plan for longer life expectancies due to family history, socioeconomic circumstances or general mortality improvements. Others will have variations in age and benefit amounts that create different results. A central feature of Social Security planning is that decisions that may once have been relatively straightforward will now need to be examined more closely. 4

Opportunities for dual-income households By default, when a program participant files for Social Security benefits, they are filing an application for all eligible benefits. 8 If the participant is eligible for both their own benefit and also a benefit based upon someone else s work record, their own retirement benefit will be paid, and an additional amount will be paid based upon the other benefit. In no case will the benefits be greater than the largest of the retirement benefit alone, the spousal benefit alone or the survivor benefit alone. In other words, when benefits are available based on more than one person s work record, the benefits are coordinated, not added together. A far more common example than John and Mary is Tom and Sarah, who both have a work history that qualifies them for retirement benefits. Initially, we ll assume Tom and Sarah both reach FRA, which is 66, in January 2017, so neither is eligible to use a voluntary suspension as part of their claiming strategy. Tom has been the higher earner and has a PIA of $2,500. Sarah has a significant work record of her own and a PIA of $1,600. In this example, both Tom and Sarah are eligible for a spousal benefit based upon the other s work record. Tom s benefit, based on Sarah s work, would be $800, and Sarah s, based upon Tom s work, would be $1,250. If Tom or Sarah file normally for benefits, each would receive only their own benefit and would not receive any spousal benefits because both amounts are greater than half of their spouse s PIA. 9 The restricted application for spousal benefits Under the law prior to BBA changes, once an individual reaches FRA, a participant may restrict their application to only a spousal benefit while allowing their own retirement benefit to accumulate delayed retirement credits. Let s revisit the example above. If Sarah were to file at 66, Tom could restrict his application to only spousal benefits, collecting $800 per month. Because he has not yet filed for his own retirement benefits, he would continue to accumulate delayed retirement credits. When Tom reaches 70, he can switch to his own retirement benefit, which will have grown to $3,300 per month. The added checks Tom can receive by restricting his application to only spousal benefits while delaying his own benefit represent an increased value of $37,945 over delaying his claim to age 70. 10 Present value of Tom s spousal benefits at age 66 66 $9,600 67 $9,524 68 $9,448 69 $9,373 $37,945 The BBA also changed the rules surrounding the restricted application. 11 Prior to the passage of the Act, anyone who reached FRA could restrict their application to only spousal benefits. The BBA limits this option to people who reached age 62 in 2015 or earlier. Because of the way Social Security measures age, this means that anyone born on or before January 1, 1954 will have the option to restrict once they have attained FRA. Those born on January 2, 1954 or later will be treated as though an application for a retirement benefit is also an application for a spousal benefit and vice versa. Further, if at any point after initial entitlement to a retirement or spousal benefit, you become eligible for the other benefit, you will be treated as though you had immediately elected the other benefit. In short, there will be opportunities to use the restricted application as part of a Social Security claiming strategy until 2024 (someone could file retroactively back to 2023 up until May of 2024), at which time all cohorts who were eligible to use the technique will have reached age 70. This technique can provide benefits of up to $63,336 12 in addition to the basic value that can be delivered by appropriately combining retirement, spousal and survivor benefits. Retirement earnings test The Retirement Earnings Test (RET) is as old as Social Security itself. The final version of the Social Security Act of 1935 contained the following provision: Whenever the Board finds that any qualified individual has received wages with respect to regular employment after he attained the age of sixty-five, the old-age benefit payable to such individual shall be reduced, for each calendar month in any part of which such regular employment occurred, by an amount equal to one month s benefit. 13 5

The original retirement earnings test applied indefinitely. If you were still earning a regular wage at 85, your Social Security benefit would be withheld. This began to change in 1950, when a maximum age of 75 was introduced. In 1954, the age was reduced to 72, and in 1977 it was reduced again to 70. Also in 1977, a second tier of the earnings test was created, so that earnings limits were relaxed for people between FRA through age 69. In 1983, the earnings limits for the second tier were substantially increased, and the penalty for exceeding them was decreased from $1 for every $2 of earnings over the limit to the current $1 for each $3 over the limit. The earnings test was again changed in 2000 when President Clinton signed the Senior Citizens Freedom to Work Act, eliminating the earnings test upon attainment of FRA. It s important for advisors to understand that changes to the Social Security system are not new. The system has changed in the past and will likely face more changes in the future; the current system is the byproduct of evolution. The patchwork of rules creates opportunities to those who are well versed in the rules and equipped with tools to identify claiming opportunities and pitfalls. Dual income split strategy For this case, we ll make Sarah three years younger than Tom and assume that both are continuing to work, with Tom making $120,000 per year and Sarah making $50,000. Sarah plans to work until at least 65, prior to being Medicare eligible, to maintain health care coverage through her employer. Tom expects to retire at the same time. At first, it might appear there is no opportunity for Tom to file a restricted application due to the earnings test that would be applicable based upon Sarah s continued work. If Sarah were to walk into a Social Security office or use Social Security Administration s earnings test calculator 14 she may be told that she earns too much money to claim benefits. Her $50,000 of income would result in an earnings penalty of $17,140. Her total benefit, if claimed at 63, would be $15,360. If she can t claim until she retires at 65, then Tom isn t eligible to claim a spousal benefit until he is 68. In this case, a thorough understanding of the earnings test is necessary to understand why Sarah can claim and why Tom will receive a spousal benefit. The key is this: the earnings penalty can be paid through all benefits on the record, not just Sarah s retirement benefit. Here s how it would work: Sarah s filing strategy: files for her retirement benefits at age 63 Tom s filing strategy: files restricted for spousal benefits at age 66, delays filing for retirement benefits until age 70 Earnings Test for Sarah and Tom Sarah s RIB Tom s Spousal Penalty amount Penalty Remaining Benefit Payable January $1,280 $800 $2,080 $15,060 $0 February $1,280 $800 $2,080 $12,980 $0 March $1,280 $800 $2,080 $10,900 $0 April $1,280 $800 $2,080 $8,820 $0 May $1,280 $800 $2,080 $6,740 $0 June $1,280 $800 $2,080 $4,660 $0 July $1,280 $800 $2,080 $2,580 $0 August $1,280 $800 $2,080 $500 $0 September $1,280 $800 $500 $0 $1,580 October $1,280 $800 $0 $0 $2,080 November $1,280 $800 $0 $0 $2,080 December $1,280 $800 $0 $0 $2,080 6 $17,140 $7,820 In this case, a thorough understanding of the earnings test allowed this couple to claim more than $15,000 of value that would otherwise have been left on the table. This is because Tom would have had to wait two years (until Sarah claimed at 65) to collect a spousal benefit, with no compensatory increase in the benefit amount. However, the earnings test penalty is eliminated by September of the first year using the split strategy. This results in the couple s ability to claim $7,820 per year for the years Sarah is 63 and 64, totaling over $15,000 in additional benefits. The split strategy will likely become far more important and far more common due to the elimination of the Voluntary Suspension as a filing strategy. Since it will often be the lower earner, who is typically younger, filing early to enable a spousal benefit for the higher earner, partial earnings test situations will be common. Advisors who are well equipped

to handle such situations stand to add a lot of value to their clients. Widow planning unchanged The BBA did not affect the strategies that are available to widows. Prior to the BBA, deeming did not apply to widow benefits and the legislation specifically avoided modifying strategies that are available to widows. A widow may use a Restricted Application to restrict benefits to either only a widow benefit, which can begin as early as age 60, while preserving the ability to grow her own retirement benefit until age 70 (76% increase from 62-70) or elect only a retirement benefit as early as age 62, while preserving the ability to switch to a widow benefit as late as FRA (for a 28.5% increase from 60-66). Because widows do not face the deeming provision even prior to FRA, an understanding of the earnings test has always been important for this group. Let s take the case of Sandy, who was born in May 1956 and widowed at age 59. 15 Her husband had not elected benefits and had a PIA of $2,000, which means that Sandy s widow benefit if she elects at 60 would be $1,430. Sandy also works, earning $30,000 per year. Her own full retirement benefit at 66 and 4 months is projected to be $2,000, meaning she would collect $1,464 per month at age 62. She expects to work until at least age 65. Sandy is over the $15,720 earnings test-exempt threshold, generating a $7,140 earnings penalty. Should she elect Social Security benefits anyway? The result in widow cases is often very straightforward in that a widow should definitely claim a benefit, even if there is a partial earnings test. 16 Sandy s widow benefit options Wait until FRA, standard claim $501,791 Widow, then retirement $641,286 Retirement, then widow $542,451 Widows should almost always claim one benefit early, even with a partial earnings penalty, because actuarial reductions (used to calculate break-even) are based on an average life expectancy. A widow who has her own earnings record, in addition to a widow benefit, will not stay on the initially elected benefit long enough for the actuarial reduction to be made up by length of time on the benefit. The only question that remains is which benefit to elect. That question depends on the life expectancy of the widow and the overall income need. While this knowledge was common to advisors who specialize in Social Security planning prior to the BBA, the passage of the BBA creates similar situations for married couples, thus highlighting the importance of the retirement earnings test for widows as well. The path forward Many advisors may believe that the passage of the BBA represents the end of Social Security planning as a core component of the retirement income plan. Savvy advisors understand that change always uncovers need. The general public needs help: Understanding the complex interaction between work and claiming Quantifying the tradeoffs that are now present Understanding tax implications with respect to their broader financial plan Determining the best course of action Although the BBA has removed a key tool in Social Security planning for couples, it has also effectively highlighted the need for advisor expertise and created marketing opportunities for advisors who are prepared with the knowledge and equipped with tools to identify strong claiming strategies. Social Security 360 Analyzer Nationwide s Social Security 360 Analyzer tool generates client-ready reports to help advisors speak confidently with clients about their filing options. It offers greater visibility on many perspectives of Social Security, and can help build a retirement income plan around clients individual needs. Created by an advisor, the tool received a 2014 Technology Innovation award from the Bank Insurance and Securities Association. The tool and report: Account for the complexity of benefits in the following areas: married, divorced, widowed, still working, already filed and pension not covered by Social Security Take the earnings test into account, which is helpful since the passing of the BBA Identify optimal and alternate filing strategy options to meet your clients unique situations Position Social Security in the context of identifying retirement income needs, showing the income gap between what the client gave as their desired income compared to the suggested, early or alternative strategies Confidently guide Social Security conversations with your clients. For more information and support, call the Retirement Institute Income Planning Team at 1-877-245-0763. Register for Nationwide s Social Security 360 Analyzer at nationwidefinancial.com/ss. 7

1 There are a variety of additional benefits that, like spousal benefits are referred to as Auxiliary Benefits. Auxiliary benefits are benefits payable to an individual based not on the individual s own work, but someone else s, such as a spouse, parent or child. 2 Social Security applies a table of factors based on changes to the National Average Wage Index in order to adjust prior year s earnings to a level that would represent the equivalent wage at the worker s age 60. 3 https://www.ssa.gov/policy/docs/workingpapers/wp108.html 4 Present Value of Cash flows through age 89, assuming a.8% Real Discount Rate treasury.gov real rates 3-3-2016. 5 $31,680 per year from age 70 through age 84, discounted by.8% Real Discount Rate based on Treasury.gov Real Rates for 3-3-2016, minus $24,000 per year from age 66 through age 84, discounted by.8% Real Discount Rate based on Treasury.gov Real Rates for 3-3-2016. 6 https://secure.ssa.gov/apps10/reference.nsf/links/02182016020549pm 7 https://secure.ssa.gov/poms.nsf/lnx/0300615320 8 https://secure.ssa.gov/apps10/poms.nsf/lnx/0200204020!opendocument&a=f 9 https://secure.ssa.gov/apps10/poms.nsf/lnx/0300202001 10 $9,600 per year from age 66 through age 69, discounted by.8% Real Discount Rate based on Treasury.gov Real Rates for 3-3-2016. 11 https://secure.ssa.gov/apps10/reference.nsf/links/02052016024404pm 12 Using maximum PIA for 2016 = 2639/2*48 months. 13 https://www.ssa.gov/history/ret.html 14 https://www.socialsecurity.gov/cgi-bin/retiretest.cgi 15 This case has a complication in that Sandy would reach her Full Retirement Age for Widow benefits at age 66, even though she won t reach her Full Retirement Age for Retirement benefits until age 66 and 4 months. Since she was born in May, and is under the higher earnings test amount for the calendar year she reaches full retirement age, we will assume she elects Widow s Benefits at 66 and receives a full $2,000 benefit amount. 16 Assuming 2016 Earnings test exempt amount of $15,720 and 2016 wages. Not a deposit Not FDIC or NCUSIF insured Not guaranteed by the institution Not insured by any federal government agency May lose value This material is general in nature. It is not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account the specific investment objectives, tax and financial condition or particular needs of any specific person. We encourage you to seek the advice of an investment professional who can tailor a financial plan to meet your specific needs. Federal tax laws are complex and subject to change. Neither Nationwide nor its representatives give legal or tax advice. Please consult with an attorney or tax advisor for answers to your specific questions. This presentation does not constitute legal or investment advice. Please consult with your tax or legal adviser. The information provided herein is general in nature and should not be construed as legal or tax advice, as such opinions can be rendered only when related to specific situations. Nationwide Investment Services Corporation (NISC), member FINRA. Nationwide Retirement Institute is a division of NISC. Social Security 360 Analyzer is a service mark of Nationwide Life Insurance Company. Nationwide, Nationwide Retirement Institute, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company. 2016 Nationwide NFM-15348AO.2 (05/16) 8