When Social Security was introduced in 1935, it was never intended to be a primary income source that could support people in retirement. Rather, its sole purpose was to provide a safety net for people who were unable to accumulate sufficient retirement savings. For the next several decades, the majority of Americans never gave much thought to their Social Security because of shorter lifespans and a reliance on guaranteed pensions.
Things are very different today. An increasing number of people are paying attention to their benefits, and Social Security planning is becoming a vital element in securing lifetime income sufficiency.
"Given today’s longevity it is more important than ever to maximize your Social Security benefit. Think of this as an annuity for your lifetime," says Charlotte A. Dougherty, CFP®, founder of Dougherty & Associates, Cincinnati, Ohio.
Although there are many planning options for receiving Social Security benefits, they can be complex and only apply in certain circumstances. The following planning tips are ones that everyone should follow in order to increase the size of their Social Security checks.
- Working for 35 years or more will help ensure you get the most money when your benefit amount is calculated.
- Aim to earn as much as you can right up until full retirement age to max out your benefit.
- If you wait until age 70 to claim, you can increase your benefit by 8% a year beyond your full retirement age.
- Claiming a spousal benefit and waiting until age 70 to take your own will allow your benefit to grow to its maximum.
- Be aware that 50-85% of your benefits may be subject to federal taxes if you earn money after you start receiving Social Security.
1. Work at Least the Full 35 Years
The Social Security Administration (SSA) calculates your benefit amount based on your lifetime earnings. The SSA adjusts your earnings, indexing them in order to take into account changes in averages wages since the years you received those earnings. Then the SSA totals your earnings from your 35 highest-earning years and uses an average indexed monthly earnings (AIME) formula to come up with the benefit you will receive at your full retirement age (see below).
If you entered the workforce late, or had periods of unemployment, those years will count as zeroes, which will be included in the formula, bringing down the average. Once you have worked 35 years, each additional year of earnings will replace an earlier year of lower earnings, which will increase the average—and hence, your benefit.
2. Max Out Earnings Through Full Retirement Age
The SSA calculates your benefit amount based on your earnings, so that the more you earn, the higher your benefit amount will be. Earnings above the annual cap ($132,900 in 2019 and indexed to inflation each year), are left out of the calculation. Your goal should be to maximize your peak earning years, striving to earn at or above the cap.
Some pre-retirees look for ways to increase their income, such as taking on part-time work or generating business income. Others, however, unaware of the impact on benefits, may scale back on their work or semi-retire, which can lower their Social Security income.
"Money earned after age 60 isn't indexed, which means that income earning in your 60s can replace a year in which there was a zero or a year in which you had lower earnings," says Marguerita Cheng, CFP®, CRPC®, RICP, CDFA, CEO of Blue Ocean Global Wealth, Gaithersburg, Md.
3. Delay Benefits
Most people know their full retirement age (FRA)—the age at which they can receive their full Social Security benefits. For most people retiring today, the FRA age is 66. But very few people know that if they delay their Social Security benefits until after they reach FRA, they can effectively earn an 8% annual return on their available benefits. The benefit amount increases by 8% each year that it is delayed until age 70. That is based on the delayed retirement credits (DRCs) earned for each year that you delay your Social Security benefits.
If, for example, you are eligible for a primary insurance amount (PIA) of $2,000, or $24,000, at age 66, then by waiting until age 70, your annual benefit would increase to $31,680. In cumulative terms, you would increase your total benefits from $378,000 received by your life expectancy at age 82 to $411,000.
This example doesn’t account for cost-of-living adjustments (COLAs). Assuming a 2.5% COLA, your delayed benefit would grow to $38,599 and your total benefit amount would increase to $584,000 by age 82. (Keep in mind that COLAs go up and down; between 2009 and 2018, there were three years when the COLA was zero.)
4. Claim Spousal Benefits and Delay Yours
If you and your spouse were born prior to Jan. 2, 1954 and have both reached full retirement age, you can claim spousal benefits and let your own benefits keep growing. Then, when you reach age 70, you can switch to your higher benefit. One caution: You can't have claimed your own benefit if you want to make use of this "restricted application," as it's called.
In order to claim a spousal benefit, your spouse must have filed for their own Social Security benefits (but ex-spouses are exempt from this rule).
5. Avoid Social Security Tax
If you are planning on supplementing your retirement income by working after you start receiving Social Security benefits, then you need to be aware of the tax consequences of increasing your income. Anywhere from 50% to 85% of your benefit payment can be subject to federal taxes.
To determine how much of your benefits will be taxed, the IRS will add your nontaxable interest and half of your Social Security income to your adjusted gross income (AGI). If that total amounts to $25,000 to $34,000 for single filers—or $32,000 to $44,000 for joint filers—up to 50% of your Social Security income is subject to tax. When that amount exceeds $34,000 for a single filer or $44,000 for joint filers, up to 85% of your benefits is subject to taxes.
You may be able to avoid paying taxes on Social Security income by considering ways to spread out your income from various sources so as to prevent any increases that could trigger a higher tax.
"Many investors have a 'tax honeymoon' period between retirement and age 70½. They have no earned income and are not required to withdraw from their IRAs yet. If they have a nonqualified account, they can withdraw tax-free principal. In this situation, it is quite possible that Social Security benefits will be tax free," says James B. Twining, CFP®, wealth manager, Financial Plan, Inc., Bellingham, Wash.
The Bottom Line
These five steps will go a long way toward helping you get the most out of your Social Security benefit and providing more financial security during your retirement. (For related reading, see "Reasons Your Social Security Check Was Short This Month")